YALE READINGS IN INSURANCE 



ZARTMAN AND PRICE 



PROPERTY INSURANCE 




Class 
Book 



H 



— ^ 



Copyright!)?.. 



COPYRIGHT DEPOSIT. 



YALE READINGS IN INSURANCE 



MARINE AND FIRE 



YALE READINGS IN INSURANCE 



PROPERTY INSURANCE 



EDITED BY 

LESTER W. ZARTMAN 

LATE ASSISTANT PROFESSOR OF POLITICAL ECONOMY, YALE UNIVERSITY 

REVISED BY 

WILLIAM H. PRICE 

PROFESSOR OF POLITICAL ECONOMY IN THE IMPERIAL UNIVERSITY OF TOKYO 




NEW HAVEN: YALE UNIVERSITY PRESS 

LONDON: HUMPHREY MILFORD 

OXFORD UNIVERSITY PRESS 

MDCCCCXIV 



Copyright 1909, 1914, by 
Yale University Press 



w& 






Printed in the United States 



DEC 23 1914 



CI.A393041 






i 



PREFACE TO THE SECOND EDITION 

Although the plates of the first edition of the "Yale 
Readings in Insurance" as edited by the late Professor 
Zartman have been preserved, the publishers decided 
upon a re-editing of the " Readings " rather than a mere 
reprint. Careful study, however, has failed to sug- 
gest the wisdom of numerous or important alterations. 
The former editor made his selections carefully, the 
recent contributions to the literature of property 
insurance have been few, and there have been no 
important changes in the conduct of the business. 

The report of the Merritt committee, which investi- 
gated the fire insurance business on behalf of the 
New York legislature, has supplied two new chapters 
to the present edition. Two other chapters were 
taken from KitchhVs " Principles and Finance of Fire 
Insurance," a work which is not less suggestive to 
American students because it deals primarily with 
English conditions. The four new chapters include 
two on the subject of finances, and one on inter- 
company organization, — subjects which were only in- 
cidentally treated in the former edition of the " Read- 
ings." Since the absence of cooperation among the 
fire insurance companies in the tabulation of experience 
is the most conspicuous evil which the companies 
could readily correct, a chapter describing tabular 
rating in Great Britain has been added to the articles 
urging scientific fire rating upon American companies. 



vi PREFACE TO THE SECOND EDITION 

It has seemed advisable to introduce an analytical 
table of contents, and this has rendered the alphabetical 
index superfluous. 

The arrangement of the " Readings" has not been 
a simple problem. Articles prepared by numerous 
writers, working independently, are apt to overlap 
here, and fail to join there. At best they lack the 
unity of a treatise by a single writer. The order in 
which they are arranged must depend largely upon 
the material. In the former edition, following the 
precedent of the "Yale Lectures" published in 1904, 
articles on "miscellaneous" branches of insurance 
were appended to a compact group of articles on fire 
insurance. In this edition an attempt has been made 
to avoid this mixed group. The articles on liability 
insurance, government insurance, and workingmen's 
insurance have been transferred to the companion 
volume, which, in the new edition, adds other branches 
of personal insurance to life insurance. The present 
volume is therefore confined to the insurance of prop- 
erty. The two chapters on marine insurance have 
been placed at the beginning since marine insurance, 
by virtue of its less scientific character as well as 
because of historical reasons, serves as a convenient 
introduction to the subject of property insurance. 
Virtually all the succeeding chapters of this volume 
are devoted to fire insurance, — an emphasis which 
is justified by its relative importance, its elaborate 
organization, and its many perplexing practical prob- 
lems. Steam boiler insurance is so largely a loss- 
preventive service that it is appropriately considered 
in connection with the prevention of loss by fire. The 
intimate relation between the subject of prevention 
of losses and the theory of insurance would have 



PREFACE TO THE FIRST EDITION vii 

made it desirable to treat these topics consecutively 
at the beginning of the volume. This arrangement 
is being followed in the companion volume on per- 
sonal insurance, but it has been found impracticable 
here. 

William H Price 

New Haven, 
June, 1913. 



PREFACE TO THE FIRST EDITION 

The "Yale Lectures on Fire and Miscellaneous 
Insurance" appeared five years ago. Although a 
considerable edition was printed, the unexpectedly 
large demand soon exhausted it, and as the plates were 
destroyed, for two years the lectures have been out 
of print. 

It seems desirable that either a new edition of the 
lectures should be printed, or that something new 
should be published in their place. The latter alter- 
native has been chosen, and instead of simply reprint- 
ing the old lectures, the plan has been adopted of 
selecting special readings, partly from the "Yale 
Lectures,' ' partly from other sources. This plan was 
preferred because the literature of fire and miscel- 
laneous forms of insurance has been developing so 
rapidly that a much more comprehensive text-book 
can now be prepared than was possible a few years 
ago. By not confining this volume to a reprint of the 
old lectures, it has been possible to take advantage of 
the advance which has taken place in this literature. 
Only seven of the lectures in the old volume are re- 



viii PREFACE TO THE YALE INSURANCE LECTURES 

printed, and all but one of these have been extensively 
changed. Some of the matter now published has 
never appeared before, and much of the remainder 
has been revised. 

The major part of this volume is devoted to the 
subject of fire insurance The general principles in- 
involved in fire insurance are typical of those found 
in all forms of insurance other than life insurance. 
The miscellaneous forms of insurance, such as marine, 
steam boiler, employers' liability, and workingmen's 
insurance, are discussed to the extent that each intro- 
duces new methods and new principles into the business. 
In selecting these readings, the aim has been to avoid 
those authors who treat the subject in technical lan- 
guage, as well as those who make the subject more 
simple than it really is, and thus conceal its real prob- 
lems. The broad selection of material would not 
have been possible without the cooperation of others. 
It is a pleasure to record the fine spirit of publishers 
in permitting reprints from copyrighted books, and 
the willingness of authors to revise articles where 
changed conditions made revision desirable. 

Lester W. Zartman 

New Haven, 

August, 1909 



PREFACE TO THE YALE INSURANCE 
LECTURES 

Published as reprinted from The Alumni Weekly, 1903-1904. 

Yale University, in launching a course in insur- 
ance on lines not previously attempted, gave official 
recognition of the profound importance and signifi- 



PREFACE TO THE YALE INSURANCE LECTURES ix 

cance of the subject, considered both from the stand- 
point of society and the individual. Insurance had 
before been taught both at Yale and at other univer- 
sities, but never on lines which entered so thoroughly 
and so deeply into the history, philosophy, economy 
and science of the subject. In opening this course, 
Yale broke new ground and the lectures which formed 
the main body of the course in insurance, of the Aca- 
demic year 1903-4, brought together an amount of 
material on this subject which had never before been 
gathered in any such form or to any such extent. 

This is said in full recognition of the large and most 
valuable body of insurance literature already in exist- 
ence. It is the point of view taken in the prepara- 
tion of this material which gives it its peculiar value 
to the students of the subject and to those who are 
interested in it either as a business or as a profession. 
The object of the course was to give the student such 
a knowledge of the fundamental principles of insurance 
and such a view of its extent and its methods of opera- 
tion as would enable him to judge accurately of its 
power as an economic force, and would further prepare 
him for wise action when the duties of his profession 
or business required him to guard himself or others 
from possible loss. It was further intended to furnish 
a broad, preliminary view of insurance for those who 
intended to enter it later, either as a business or as a 
profession. 

These two classes of men are found in very large 
quantities outside of the list of students of any and 
all American universities and the publication of these 
lectures is intended to give them, as well as those who 
are making an academic study of insurance, the ad- 
vantages which were first given to the students of 



X PREFACE TO THE YALE INSURANCE LECTURES 

Yale who elected this course. It is also believed that 
these lectures will be welcomed by those who are 
actively engaged in insurance work because they put 
in such clear and interesting form many of the most 
important facts, principles and problems of the sub- 
ject. In other words, it is hoped that the publication 
of these lectures will furnish not only a text-book for 
those who have the advantages of academic study 
but a source of information to the general student and 
of practical assistance to the insurance worker. 

Those into whose hands this volume will fall will, 
we think, unite in grateful acknowledgment to all 
the men who gave their services in the preparation of 
these lectures out of their study and experience. To 
them the editors of this book certainly wish to render 
their sincere thanks for their cooperation in the prepa- 
ration of the volume, and no less to the men, Mr. 
A. A. Welch of Hartford and Dr. John M. Gaines of 
New York, whose services in the difficult work of the 
quiz made the first and experimental year at Yale a 
success, and helped so materially to establish the lines 
on which this subject could in the future profitably 
be continued as an integral part of the education 
furnished by a university. 

The Editors 



CONTENTS 

MARINE INSURANCE 

Chapter I. — History of Marine Insurance. By Solomon 

Huebner 1-38 

- Marine underwriting not on a scientific basis, 1; impor- 
tance of marine insurance to commerce, 2; the earliest branch 
of insurance, 3; bottomry loans, 3; marine insurance in 
Italy and Western Europe, 4; insurance law, 5; Lloyds, 6; 
marine insurance companies, 7; three-fold purpose of Lloyds, 
7; the intelligence department, 8; publications, 8; corpo- 
ration of underwriters, 10; organization, 11; underwriting 
routine, 12; re-insurance, 14; marine insurance in the 
United States, 14; in the eighteenth century, 15; the In- 
surance Company of North America, 16; other companies, 
17; their vicissitudes to 1840, 18; prosperity, 1840-1860, 
22; subsequent decline, 23; the iron steamship, 23; the Civil 
War, 23; the policy of Lloyds, 26; the entrance of foreign 
companies, 28; financial contrast between British and Ameri- 
can companies, 29; underwriting statistics, 31; self-insurance, 
36-38. 

Chapter II. — The Policy Contract in Marine Insurance. 

By A. A. Raven 39-58 

The perils covered, 40; letters of mart and counter-mart, 
40; barratry, 41; the memorandum, 42; the underwriter, 
42; warranties (implied), 43; the Harter act, 45; factors 
determining the premium, 45; average, general and par- 
ticular, 46; jettison, 47; salvage, 48; written and printed 
portions, 50; valued, and wager, policies, 51; collision, 52; 
fire, 54; constructive total loss, 54; vessel, and freight, in- 
surance, 55; charter, 55; insurance of profits, 55; settlement 
of losses, 56. 

HISTORY OF FIRE INSURANCE 

Chapter III. — History of Fire Insurance in Europe. By 

Richard M. Bissell 59-69 

Early history, 59; the great fire of London in 1666, 61; 
Barbon's Fire Office, 61; the Friendly Society, 62; the 
Amicable, or Hand-in-Hand, 62; Povey and the Sun Fire 
Office, 63; the Royal Exchange, and the London, Assur- 



xii CONTENTS 

ance Corporations, 64; fire protection, 65; patrols and 
brigades, 66; fire insurance on the continent of Europe, 67; 
the Code Napoleon, 69. 

Chapter IV. — History of Fire Insurance in the United 

States. By F. C. Oviatt 70-98 

Fire insurance in England, 70; in Philadelphia, 72; the 
Philadelphia Contributionship, 72; perpetual insurance, 73; 
the Insurance Company of North America, 73; brick and 
frame hazards, 73; fire insurance in New York, 73; in New 
England, 74; the Hartford Fire Insurance Company, 76; its 
expansion, 77; the iEtna, 78; the multiplication of com- 
panies, 79; the New York fire of 1835, 80; the earliest 
classification of risks, 80; unearned premium legislation of 
Massachusetts and New York, 81; the rise of the mutuals, 
82; the township mutuals, 83; the mill mutuals, 84; local 
boards, 84; fire patrols, 85; adjusters, 85; Western depart- 
ments, 86; absence of adequate surpluses, 87; the National 
Board of Fire Underwriters, 88; the daily report, 88; special 
agents, 89; maps, 90; the Pacific coast, 91; the Chicago fire, 
91; demoralization of rates, 92; rating boards, 93; the 
standard policy, 93; inspections, 94; sprinklers, 94; schedules, 
95; inconvenient legislation, 95; taxes, 96; American Lloyds, 
96. 

THEORY OF INSURANCE 

Chapter V. — Function of Fire Insurance. By Allan H. 

Willett 99-120 

Insurance, 99; self-insurance, 100; accumulation of capital, 
transfer of risk, and combination, 100; the gain from combi- 
nation, 101; illustration, 102; cheap insurance should nor- 
mally result from large companies, 105; the estimation of 
risk, 106; cost of the insurance business, 106; prevention, 107; 
appraisal, 107; moral hazard, 107; erroneous conceptions, 
108; prevention, insurance, and assumption of risk, 111; 
capital alone can insure capital, 113; mutual and stock com- 
panies, 114; relation of accumulations to risks, 115; insurance 
and productivity, 116; is all insurance mutual? 118; the 
place of insurance in economic theory, 119; summary, 120. 

FIRE INSURANCE ORGANIZATION 

Chapter VI. — Organization of Companies. By Richard M. 

Bissell 121-139 

Local mutuals, 121; their formation, 122; their methods, 
122; mutual surveillance, 123; low rates, 123; state mutuals, 
124; not generally successful, 125; factory mutuals, 127; 
their progress after the Chicago fire, 128; their remarkable 
achievements in loss prevention, 128; their investigations, 



CONTENTS xiii 

129; imitated by the stock companies, 130; mutual contract 
not suitable in congested districts, 130; Lloyds, or voluntary 
partnership, 131; their reliability, 131; stock companies, 132; 
their administration, 133; field organization, 133; local 
agents, 135; examiners, 135; the auditing department, 136; 
the loss department, 137; district offices, 137; general offices, 
138; brokers, 138. 

Chapter VII. — Organization Among the Companies. From 

Merritt Committee Report 140-147 

The National Board of Fire Underwriters, 140; the National 
Fire Protection Association and the Underwriters' Labora- 
tories, 141; the New York Board of Fire Underwriters, 141; 
the New York Fire Insurance Exchange, 142; the Suburban 
Fire Insurance Exchange, 144; the Underwriters' Associa- 
tion of New York State, 145; the Buffalo Association of 
Fire Underwriters, 146; advisory raters, 146; the Eastern 
Union, and the Western Union, 147. 

FIRE RATING 

Chapter VIII. — Rates and Hazards. By Richard M. 

Bissell 148-180 

"Risks" and their hazards, 148; physical hazards, 149; 
external hazards, 149; exposure hazards, 149; internal hazards, 
150; spontaneous combustion, 150; operation of machinery, 
150; processes, 151; heating and lighting, 151; carelessness, 
152; sub-division of hazards, 153; moral hazards, 154; the 
foundation of basis rates, 156; apportionment of cost, 157; 
obstacles in the way of combined experience, 158; laGk of 
uniform classification, 158; changing processes, 158; new 
hazards, 159; new methods of light, heat, and power, 159; 
public hostility toward combination of any sort, 160; the 
individual risk, 161; judgment-rate system, 161; schedule 
rating, 163; elaborate analysis of risks, 163; partial loss and 
co-insurance, 164; standard building, and basis rate, 165; 
deficiencies and credits, 166; exposure, 166; penalty rating, 
167; a typical schedule, 168; contents rates, 168; the rating 
of frame mercantile buildings, 169; the Universal Mercantile 
Schedule, 170; how prepared, 171; standard city, standard 
building, basis rate, and key rate, 172; occupancy charges, 
173; the Dean Schedule, 174; its starting point, 174; per- 
centage additions, 175; the differential for contents, 177; 
exposure formulae, 178. 

Chapter IX. — Scientific Fire-Rating 

I. By Miles M. Dawson 181-200 

Theory of insurance, 181; classification of risks and com- 
putation of costs, 183; life insurance deficient in the former 



xiv CONTENTS 

practice, fire insurance in the latter, 184; fire insurance rates 
and railway rates, 186; elaborate classification requires abun- 
dant data, 187; companies should pool their statistics, 189; 
how the data should be arranged, 189; the conflagration 
hazard, 190; conflagration reserves and safety funds, 191; 
tabular rating would prevent costly competition, 192; would 
disarm prejudice, 193; would have a steadying effect upon 
rates, 193; especially if cost schedules were accepted by state 
legislatures as standards of solvency, 194; would help to 
solve the commission problem, 194; would facilitate the 
adoption of participating rates, 196; would widen the scope 
of insurance, 196; and would probably result in great im- 
provement in schedules, 198; the task not formidable, 200. 

II. By A. F. Dean 200-208 

Tabulation by individual offices, 200; table illustrating 
variations among different tabulations, 202; lists vitiated 
by careless compilation, 203; and by fluctuation of rates, 
204; and by uncertain groupings, 205; these faults may be 
easily corrected, 206; obstacles, 206; reform inevitable, 208. 

Chapter X. — Tabular Rating in Great Britain. By F. 

Harcourt Kitchin 209-224 

Object of rates, to meet losses, 209; and to diminish losses, 
210; differential rating in fire insurance, and ship-building 
under survey, 210; data in possession of individual com- 
panies, 212; how a tariff is framed, 213; high rates not 
desired, 214; list of British tariffs, 217; no systematic dis- 
tinction between towns, 217; exceptions, 218; no standard 
city, 219; elaborate rules as to standard building, 219; ex- 
ample, — the cotton mills tariff, 220; investigations into the 
causes of fires, 222; same rate for building and contents, 224. 

Chapter XI. — Discrimination and Cooperation in Fire 
Insurance Rating. By Lester W. Zartman 

I. Discrimination 225-240 

Good building a business proposition, 225; insurance rates 
determine the character of construction, 226; complexity of 
fire hazards, 227; development of scientific fire rating, 228; 
schedule rating, 229; still based upon judgment rather than 
evidence, 231; this accounts for abundant discriminations, 
232; "preferred" risks, and "special" risks, 232; discrimina- 
tion between classes of risks, 233; between localities, 235; 
between specific risks, 237; the disbursement of premium 
income, 238; fixed and variable expenses, 239; reductions for 
improved construction, 239; summary, 240. 

II. Cooperation 241-249 

Objects of cooperation, 241; "compact" rating, 242; 

regulation of commissions, 242; supervision of risks, 243; 



CONTENTS xv 

study of hazards, 245; repression of incendiarism, 245; anti- 
compact laws, 246; their unwisdom; 246; benefit only the 
powerful and shrewd property owners, 248; demoralization 
under unrestrained competition, 248; association not viewed 
with hostility in European countries, 249. 

FIRE INSURANCE CONTRACTS 

Chapter XII. — The New York Standard Fire Insurance 

Policy 250-257 

Chapter XIII. — The Nature op the Policy Contracts. 

By Richard M. Bissell 258-281 

Policy covers actual immediate damage, 258; a personal 
contract, 258; insurable interest, 259; property must be 
carefully described, 259; good faith and candor on the part 
of insured, 260; evolution of the policy, 261; movement 
toward uniformity of policy, 262; the New York standard 
policy, 262; other standard policies, 263; commentary on the 
paragraphs of the New York policy, 263-272; interpretation 
by the courts, 272; little litigation, 272; "endorsements," 
273; the mortgage clause, 273; partial loss, 275; the per- 
centage-value clause, 276; the co-insurance clause, 276; 
the three-quarters loss clause, 278; the iron-safe clause, 
278; the distribution-average clause, 279; specific, floating, 
general, concurrent, and perpetual policies, 280; diversity in 
state requirements, 281. 

Chapter XIV. — The Co-Insurance Clause 

I. By Francis C. Moore 282-287 

Full co-insurance, 282; percentage co-insurance, 283; 

illustrations of the fairness of co-insurance, 283, 285; dis- 
tribution-average and co-insurance, 285. 

II. By A. F. Dean 287-292 

Over-insurance and under-insurance, 287; the need of a 
uniform relation between insurance and value of property, 
288; co-insurance the almost universal solution, 288; pro- 
hibited by some of the United States, 289; co-insurance 
operates in favor of small proprietors, 289; specific insurance 
and "the blanket form with co-insurance," 290. 

Chapter XV. — Valued-Policy Laws 

I. By A. F. Dean 293-298 

Valued-policy laws, 293; over-insurance and moral hazard, 

294; explanation of the legislation, 294; costly legislation, 297. 

II. By D. A. Heald 298-303 

Ohio statistics, proving that valued-policy legislation results 
in increased loss ratios, 299; Wisconsin figures to the same 
effect, 301. 



xvi CONTENTS 

III. From 31st Massachusetts Insurance Report . 303-8 

Valued policies ought not to be permitted, 303; open 
indemnity preferable, 304; valued policy not a contract of 
indemnity, 305; heavy cost of initial valuation and frequent 
revaluations, 305; possibilities of fraud, 305; a wager con* 
tract, 306; companies not prone to litigate, 307. 



FIRE INSURANCE FINANCES 

Chapter XVI. — Fire Insurance Finance. By F. Harcourt 

Kitchin 309-322 

Importance of limiting "lines" and distributing risks, 309; 
no luck in prudent fire underwriting, 310; the hunger for 
size, 310; expenses, 310; dividends come from interest rather 
than from insurance earnings, 311; wide range in annual 
profits, 312; British offices strive to maintain steady dividends, 
by holding large but fluctuating reserves, 312; reserves, 314; 
four functions of reserves, 315; reserves for unexpired risks 
should be listed separately, 317; how calculated, 318; in 
the United States, 320; the folly of paying dividends at the 
expense of reserves, 321. 

Chapter XVII. — Expense Problems. From Merritt Com- 
mittee Report 323-338 

Distribution of expenses, 323; importance of the agent, 
323; anomalous position of the agent, 324; his interest not 
identical with that^of his company, 325; competition among 
companies has largely taken the form of high commissions 
to agents, 326; "Union" commissions, 326; "Bureau" com- 
missions, 327; commissions on preferred risks, 328; proposed 
legal limitation of commissions, 329; contingent commissions, 
329; a standard of competency for agents, 331; expenditure 
for prevention, 331; brokers, 332; brokers act as expert 
advisers for their clients, 333; but are paid by the companies, 
334; a standard of competency for brokers, 335; brokers' 
pledges, 336; brokers' commissions, 337; rebates, 338. 

Chapter XVIII. — Conflagration Reserve. By A. W. 1 

Whitney 339-347 

The conflagration hazard, 339; rate covers hazard, expense, 
and profit, 339; except for conflagration hazard, fire insur- 
ance would be a business of great steadiness, 340; but with the 
conflagration hazard, the average for many cities and many 
years is far from stable, 340; the "surplus" of a fire insurance 
company is more properly a "conflagration reserve" (a 
liability), 341; this conflagration reserve should be deter- 
mined by the amount of the risks exposed to a single conflagra- 



CONTENTS xvii 

tion, 342; only stock companies can meet the conflagration 
hazard, 342; a law for conflagration reserves would be as wise 
as one for unearned premium reserves, 343; and such reserves 
should constitute the limit of liability, 343; reckless under- 
writing would be prevented, the protection of the insured would 
be standardized, and underwriters would be encouraged, 344; 
there is a dearth of good insurance in the large cities, 345; 
limited liability has not gone far enough, 346; the conflagration 
hazard is at least half as great as the ordinary hazard in the 
larger cities with respect to mercantile stocks, and several 
times as great with respect to " fire-proof " buildings, 347. 



PREVENTION OF LOSSES 

Chapter XIX. — Fire Insurance Engineering. By Fred- 
erick C. Moore 348-360 

Definition, 348; the inspector, 348; his duties, 350; in- 
spection bureaus, 351; the National Fire Protection Associa- 
tion, 352; the Underwriters' Laboratories, 353; exposure 
hazards, 354; floor openings, 355; segregation of special 
hazards, illustrated by the cotton-mill, 356; new hazards, 
357; fire protection, 358; contrasts between fire risks in 
European countries and the United States, 358. 

Chapter XX. — Fire Protection with Automatic Sprin- 
klers. By Frederick C Moore 361-368 

Description of sprinklers, 361; installation, 362; testing, 
363; expert survey, 363; benefits given by sprinklers, 364; 
cost, 364; the gain from instantaneous action, 365; inspections, 
366; limitations of sprinklers, 367; depreciation, 368. 

Chapter XXI. — Factory Mutual Fire Insurance. By 

Edward Atkinson 369-391 

Origin in Providence, R.L, 369; the Boston Manufac- 
turers' Mutual, 369; the dormant right of assessment, 370; the 
picker risk, 370; the fundamental rule of the mill mutuals, 
370; the Chicago and Boston conflagrations, 371; the senior 
and the junior mutuals, 372; the assessment right, 372; in- 
spections, 372; changes introduced about 1878, 373; joint in- 
spections and joint classification, 374; adoption of automatic 
sprinklers, 374; apparently no conflagration hazard, 375 and 
377; but mutuals avoid the most congested districts, 376; no 
arson and no litigation, 376; adjustments of losses, 377; 
character of the assured, 378; investigation and elimination 
of the causes of fires, 379-388; appalling fire losses in the 
United States, 388; further possibilities for mutual methods, 
389. 



xviii CONTENTS 

Chapter XXII. — Steam Boiler Insurance. By A. D. 

Bjsteen 392-408 

Boiler explosions, 392; the Hartford Steam Boiler In- 
spection and Insurance Company, 392; prevention, 393; 
distribution of disbursements, 393; the duration of the policy, 
394; the amount and the premium, 395; extraordinary 
hazards absolutely refused, 396; the application, 397; exami- 
nation of the risk, 397; the report, 399; correction of defects, 
400; review of report, 400; protection afforded by the policy, 
401; periodical inspections, 403; settlement of losses, 406; 
the economy of insuring, 407. 



YALE HEADINGS IN INSURANCE 
MARINE AND FIRE 
CHAPTER I 

HISTORY OF MARINE INSURANCE 1 

In discussing marine insurance one deals with a subject 
far more technical and complex than any other system of 
indemnity. Fire insurance provides against loss occa- 
sioned by a single occurrence. Life insurance insures 
against an event, the occurrence of which is inevitable, 
and the risk concerning which has been approximately 
measured by the application of the law of average to 
accumulated data. Marine insurance, however, under- 
takes to indemnify a person against the loss of ship, goods, 
freight, anticipated profits, or any other insurable interest, 
through any of the numerous perils and adventures con- 
nected with navigation, such as the perils "of the sea," 
fires, collisions, pirates, thieves, seizures and restraints, 
jettisons, barratry of the master or mariners, and all other 
perils, losses or misfortunes which might be assumed by 
the policy. 

While determined efforts have been made for years, and 
with success, to place the prosecution of life and fire in- 
surance upon a scientific basis, this can scarcely be said 
of marine underwriting. Some of our leading marine com- 
panies, it is true, do possess a large mass of experience 
which is used as a basis in computing rates. Yet it is 
also true that, taking the business as a whole, there is 
no other branch of insurance in which success is so largely 

1 By Solomon Huebner. A lecture at the University of Pennsyl- 
vania. Reprinted from pages 421-452, Vol. XXVI, Annals of the 
American Academy of Political and Social Science, September, 1905. 

1 



2 YALE READINGS IN INSURANCE 

dependent upon the native sagacity, the keenness for obser- 
vation, and the general specialized ability of the individual 
underwriter to know not only men, but the effect of climate, 
seasons, geographical localities and numerous other con- 
siderations upon any of a large number of risks, as in 
marine insurance. To a very large extent the business 
is inherently a system of estimates, and the importance 
of the personal qualities of the underwriter cannot be 
over emphasized. 

It is this complex nature of the business which is no 
doubt responsible for the fact that marine insurance is 
to-day a comparatively little-known business to the gen- 
eral public. Consult any of our leading insurance jour- 
nals, and a score or more of pages will be found dealing 
with other lines of insurance for one dealing with this, 
the oldest and possibly the most interesting, and, in many 
particulars, equally important branch. This compara- 
tive absence of notice, however, should not cause us to 
overlook the fact that in this country alone, between six 
and seven billion dollars worth of property is insured 
by marine companies, and that it is through this form 
of insurance that participation in commerce becomes 
general and continuous. It is not to be supposed that 
people would risk their fortunes in enterprises surrounded 
with so many dangers as mercantile ventures, were it 
not for the indemnifying contract, which in distributing 
the loss of a few among the many, removes the sense of 
fear and makes the mercantile industry one of certainty 
in its results instead of a half-gambling enterprise. As a 
prominent writer on mercantile affairs correctly states: 
" Marine insurance bears to commerce the relation of 
body-guard rather than of mere servile attendant. . . . 
Of the active forces which influence, control, or forbid the 
employment of shipping, none have greater effect than 
the marine insurance power." 1 Marine underwriting may 
indeed be characterized as just as much an instrumen- 

i William W. Bates. The " American Marine," p. 219. 



HISTORY OF MARINE INSURANCE 3 

tality of commerce and almost as necessary to navigation 
as the ship itself. It is universally recognized as a most 
important factor in trade and transportation, and in 
modern commerce is of the utmost utility. To this may 
be added that, as the methods of conducting oversea 
trade are being constantly transformed, marine insurance 
is becoming an increasingly important adjunct of com- 
merce. As Mr. Gow correctly says: "When large trans- 
actions are worked, as is now extremely common, with 
credits and margins, the amount of the premium of insur- 
ance is often the item that decides whether some venture 
will be attempted or not. The protection which marine 
insurance affords is now usually regarded as an absolute 
necessity to the oversea merchant; and thus by degrees 
marine insurance has become in one shape or another an 
integral, almost an essential, factor in oversea commercial 
transactions." 1 

The practice of marine insurance may be regarded as 
the earliest form of indemnity, antedating other kinds of 
insurance by many hundred years. Even centuries before 
the introduction of marine underwriting as we know it 
to-day, the commercial nations of the ancient world se- 
cured the benefits of insurance through the so-called "loans 
on bottomry," e.g. loans made on the security of the ship 
and cargo at high rates of interest, and with the under- 
standing that the principal with interest was to be repaid 
only in the event of the safe arrival of the vessel, and that 
the lender was to forfeit both principal and interest in case 
of loss. Instead, then, of paying a premium before start- 
ing the voyage, as is now the case, and receiving the indem- 
nity after a loss is incurred the insured under the bottomry 
loan received the indemnity in advance, and only returned 
the same plus a premium after safe termination of the 
voyage. 

Such loans on bottomry, we are told, were especially 
sought after and entered into by members of the Roman 

1 Willam Gow. " Marine Insurance, " p. 2. 



4 YALE READINGS IN INSURANCE 

nobility, who, too proud to interest themselves directly in 
commerce, and yet desirous of obtaining large interest re- 
turns, could here find a convenient method of investing 
their funds profitably, and at the same time avoid en- 
gaging personally in mercantile pursuits. That such loans 
were prevalent among the commercial peoples of early 
history is attested by the numerous references concerning 
such transactions which are found in the judicial and other 
literature of the Romans. In an edict of the Roman 
Emperor Justinian of .a.d. 533, for example, the rate of 
premium on such loans was fixed at 12 per cent., implying 
at least that the practice must have been very general at 
that time. Though indirect in form and partaking merely 
of the nature of quasi-insurance, this method of indemni- 
fying loss by means of loans was nevertheless real insurance 
in its results. It should be borne in mind, however, that 
this method of indemnification is the only one approxima- 
ting modern insurance of which antiquity furnishes us any 
clear and direct evidence. It might seem remarkable, 
indeed, that nations so far advanced in their legal systems 
as were the Mediterranean countries, and with such exten- 
sive commercial interests, should have left us no direct 
and conclusive evidence to show that they at all under- 
stood marine insurance as it is now practised. 

Marine insurance as it exists to-day originated at a much 
later date than the loan on bottomry. Evidence seems to 
show that it had its start in Italy, especially among the 
Lombard merchants, at the close of the twelfth and the 
beginning of the thirteenth century. From thence it 
spread to Flanders, Portugal, and Spain during the four- 
teenth and fifteenth centuries, and was finally carried to 
England by the Lombards in the early part of the six- 
teenth century. As early as 1601 the British Parliament 
declared marine insurance to have existed from time 
immemorial (43 Elizabeth, C. 12), and described it as a 
means "whereby it cometh to pass that upon the loss or 
perishing of any ship there followeth not the undoing of 



HISTORY OF MARINE INSURANCE * 5 

any man, but the loss lighteth rather easily upon many 
than heavy upon few, and rather upon them that adven- 
ture not than upon those who do adventure; whereby all 
merchants, especially those of the younger sort, are allured 
to venture more willingly and more freely." 

Following its introduction in England, marine insurance 
spread to the various commercial centers of Europe, its 
application becoming very general, if judged from the con- 
sideration given to the subject in the numerous commercial 
codes and ordinances of the fifteenth, sixteenth, and seven- 
teenth centuries. Finally, there followed the epoch-making 
Ordinance de la Marine of 168.1, which became the model 
for practically all the modern codes of commercial law on 
the continent, including the law of marine insurance. In 
England, on the contrary, the development of the law 
concerning sea insurance did not begin to assume such 
clear and definite form until almost the middle of the 
eighteenth century. It was then that Lord Mansfield, 
in his efforts to formulate the commercial law of England, 
began to draw his legal principles very largely from the 
commercial ordinances and codes of the continent with 
a view of applying them to English conditions. His 
decisions practically constitute the foundation of marine 
insurance law in England, and in turn have become the 
basis of American decisions. As supplementing this 
lengthy and continuous legal development, it is important 
to note that the Lloyd's policy prevailing in England 
to-day is very similar to the policy which was in use in 
the early part of the seventeenth century, and that many 
features of the English policy have in turn been incor- 
porated in the policies used in America. In other words, 
we have in marine insurance several centuries of usage 
and judicial interpretation relating to the signification of 
a single document. 

Turning now to the financial development of the busi- 
ness as distinct from the legal, marine insurance has 
naturally reached its highest efficiency in the United 



6 YALE READINGS IN INSURANCE 

Kingdom. Its history in that country, whose merchant 
marine for many decades comprised nearly half of the 
ocean-going tonnage of the world, has been rendered 
famous by the close identification of the business with 
the world renowned corporation of Lloyds. This gigantic 
institution had its origin in a mere seamen's coffee house, 
established by an Edward Lloyd near the middle of the 
seventeenth century. This enterprising and energetic 
man, besides making his coffee house a convenient place 
of meeting of merchants and seamen, also created an 
elaborate system of home and foreign correspondents to 
supply him with news from all the leading ports of the 
world concerning the movements and character of vessels 
for the information of his patrons. In fact, at first the 
underwriting of marine risks was a subordinate feature of 
his business. The systematic manner, however, in which 
maritime information was collected and disseminated soon 
won for him a large following, and made his coffee house, 
among the many others existing in London, the principal 
meeting place for merchants and professional underwriters 
who, unhampered by any rules or regulations, assembled 
there and transacted a general marine business. Thus it 
came to pass that Lloyds soon outgrew its early usefulness, 
was transferred in 1692 from its original location in Tower 
Street to Lombard Street, and finally, in 1774, to the 
Royal Exchange of London, and there developed into 
the chief center of marine insurance in the United King- 
dom, and, for that matter, in the world. 

From this account it is not to be inferred that marine 
insurance in the United Kingdom is confined to Lloyds 
or to British shipping. Prior to the beginning of the 
eighteenth century the business was, it is true, confined 
almost entirely to the plan of Lloyds, according to which 
individuals assumed risks upon the strength of their per- 
sonal honesty and financial standing in the community. 
Indeed, it was the practice of various individuals sub- 
scribing their names to the insurance contract for a certain 



HISTORY OF MARINE INSURANCE 7 

portion of the total risk that gave rise to the familiar term 
"underwriter." But gradually companies began to par- 
ticipate in the same business that Lloyds was pursuing. 
The movement seemed to gain strength rapidly, when, 
in 1720, the British government in return for a payment 
of £300,000 to the Exchequer limited the privilege of 
insuring marine risks to only two companies besides Lloyds, 
namely, the London Assurance Corporation and the Royal 
Exchange Assurance Corporation. Shortly after, however, 
this monopoly was removed and since then, especially 
during the nineteenth century, numerous corporations in 
London, Liverpool, and Glasgow, with vast accumulated 
assets and far-reaching importance, have risen alongside 
the unique and unrivaled corporation of Lloyds, and, like 
that institution, have extended their influence to all 
corners of the earth. So effective, in fact, has the compe- 
tition of the powerful insurance companies become that 
Lloyds, although yet the center of attraction in the marine 
business, has largely ceased to possess the dominating 
influence of former days. It is estimated that Great 
Britain to-day transacts about six-eighths of the sea insur- 
ance of the world, a proportion so large that one can look 
for an explanation only to the preponderating importance 
of Great Britain as a shipping nation. 

The supreme importance of Lloyds in marine insurance 
from an international standpoint justifies a brief explana- 
tion of its organization and purposes. Until quite recently, 
Lloyds was an unincorporated body where underwriters 
assembled and transacted business at will, subject to few 
or no regulations. In the year 1871, however, Lloyds 
became an incorporated organization, and, according to 
the act of incorporation, now exists for the three-fold pur- 
pose of conducting an insurance business, of protecting 
the commercial and maritime interests of its members, 
and of collecting and disseminating information pertaining 
to shipping. 

To obtain a clear view of how this three-fold purpose is 



8 YALE READINGS IN INSURANCE 

realized, it is essential to study the institution of Lloyds 
from two points of view, namely, the intelligence depart- 
ment and the corporation of underwriters. For the sake 
of convenience we may consider the intelligence depart- 
ment first, since the collection and diffusion of maritime 
information is a prime prerequisite to successful under- 
writing. Briefly described, this department consists of 
numerous agents situated in every part of the world, whose 
position is considered one of the highest honor and impor- 
tance, and whose duty it is to forward promptly informa- 
tion to headquarters concerning the arrival and departure 
of vessels, the occurrence of wrecks and accidents, or any 
other events which vitally affect shipping. As represen- 
tatives of Lloyds, these agents are also required to render 
aid to masters of vessels in distress, to take charge of a 
wrecked vessel's stores and materials in order to avoid 
unnecessary loss, to adopt precautionary measures against 
dishonesty when it becomes necessary to repair ships, and 
in a general way to protect the interests of the under- 
writers. To supplement the efforts of these agents, Lloyds 
also desires the masters of vessels to report to the nearest 
Lloyds' agent any information of interest concerning other 
ships which they might have seen or spoken with while 
on their voyage. 

All the information thus obtained by Lloyds from agents 
and shipmasters from all parts of the globe is next analyzed 
and distributed for the benefit of underwriters and sub- 
scribers. This brings us to the next important feature of 
Lloyds, namely, its publications. These are five in number, 
namely: 

(1) Lloyds' List. The official daily publication of the 
corporation containing all shipping news as currently re- 
ceived, and generally recognized as the most reliable among 
the various sources of maritime intelligence. 

(2) Lloyds' Register of British and Foreign Shipping. 
An annual publication founded in 1834, and designed to 
indicate the general character of all vessels in the British 



HISTORY OF MARINE INSURANCE 9 

marine of not less than one hundred tons, besides numerous 
vessels in foreign fleets. Among other items, this publica- 
tion states the name, materials of construction and state 
of repairs of the ship, its dimensions, registered tonnage, 
and general equipment, the date and place of construction 
and by whom constructed, the name of the owners, the 
port to which the vessel belongs, and the date of the last 
survey, and, finally, the name of the master and the date 
of his appointment. To keep the shipping world informed 
of any variations which may occur, supplementary lists 
are published monthly in connection with the annual 
edition of the Register. In other words, this annual regis- 
ter may be likened to a catalogue of nearly all the important 
vessels of the world, from which the underwriter may 
ascertain by a hurried reference the general fitness of a 
specified vessel to make a given voyage or carry a certain 
cargo. To render such reference on the part of the under- 
writer still easier, both iron and wooden vessels are each 
divided into separate classes, and these classes into grades, 
each grade being designated by a conventional symbol. 1 
Lloyds' Register is thus the handbook of the underwriter: 
but it should always be kept in mind that while it is of 
the greatest service to those who accept marine risks, it 

1 Since the classification of vessels is fundamental in the shipping 
and insurance business, the importance of a publication like Lloyds' 
Register can not well be overestimated. Its influence became so potent 
a factor in British shipping that other nations were obliged to adopt 
a similar system, until to-day Lloyds' Register constitutes the standard 
after which all other maritime nations have modeled their own regis- 
ters. To such an extent has classification of vessels become a neces- 
sary adjunct to the shipping industry, that practically no vessel of 
any importance in any nation is without a regular classification in some 
standard register. Chief among the registers now published in addi- 
tion to Lloyds are the Register of American Shipping and the Amer- 
ican Lloyds of the United States, the Bureau Veritas of France, the 
Germanische Lloyd and the Stettiner Register of Germany, the Austro- 
Ungarian Veritas of Austria, the Nederlandische-Wereinigung of Hol- 
land, the Norske Veritas of Scandinavia, and the Veritas Hellenique of 
Greece. 



10 YALE READINGS IN INSURANCE 

is controlled by authorities of its own, and is an institu- 
tion entirely distinct in its organization from the corpora- 
tion of underwriters. 1 

(3) The Index. A list of all British mercantile vessels, 
together with numerous foreign ships, showing their con- 
dition and location according to the latest reports. This 
publication is not only open to inspection at Lloyds, but 
members and subscribers, wherever situated, may upon 
request obtain the latest news concerning any particular 
vessel. 

(4) A Register of Captains. A biographical dictionary 
containing a record of the service, proficiency, and char- 
acter of the twenty-five thousand or more certified com- 
manders of the British marine, and 

(5) A Record of Losses, frequently called the Black 
Book. 

Turning now to the corporation of underwriters, as 
distinct from the intelligence department, it is of interest 
to note that its membership consists of two classes: (1) 
the underwriting members who write insurance for their 
own profit, subject, of course, to the rules and require- 

1 In the modern system of classification, as Professor Gambaro 
explains, "Ships are divided into three classes, according to the 
degree of confidence to be placed in their seaworthiness. A vessel 
recently and strongly built, well rigged and equipped, is assigned for 
a number of years to the first class, and may, therefore, during such 
period be employed with full confidence in any voyage, for the con- 
veyance of any kind of merchandise; provided, of course, that she 
suffer no deterioration or damage as may render her unserviceable, 
and be maintained in good state of repair, which is ascertained by 
periodical surveys. A second term of the same class is often granted to 
ships proving still strong, and in a good state of preservation after the 
first period. A special distinction over and above the highest classi- 
fication may be obtained for a ship, provided, such materials be used in 
her build as directed by the committee. Vessels which have gone 
through this first class term are assigned to the second, and lastly, to 
the third class; the latter embracing vessels in very poor condition, 
considered fit only for short and easy voyages, and to carry cargoes 
not to be damaged by sea- water, such as timber, salt, etc." — Gam- 
baro 's "Lessons in Commerce," p. 137. 



HISTORY OF MARINE INSURANCE 11 

ments imposed by the managing committee of Lloyds, 
and (2) the non-underwriting members, who, as brokers 
and merchants, transact business through the under- 
writing members either for themselves or others. In 
addition to these two classes, there are also numerous 
subscribers to Lloyds for the information received at the 
Royal Exchange, many of whom are British and foreign 
insurance companies. Here it remains to be said that 
practically all the great marine insurance companies of 
the United Kingdom (and they number some thirty or 
more), even though their marine business in the aggregate 
far exceeds that of Lloyds, must nevertheless be repre- 
sented on its floor, and must necessarily and continually 
receive the assistance of that organization in the prose- 
cution of their business. 1 

As a corporation Lloyds resembles our stock exchanges 
in many particulars. It assumes no responsibility what- 
ever for the solvency of its members. It seeks only to 
provide proper facilities to its members for the conduct of 
their business, and to limit admission to men of recog- 
nized honesty and financial standing. As a guarantee 
for the fulfilment of contracts, each underwriting member 
is required to deposit with the committee of Lloyds securi- 
ties to the value of £5000. Aside from this requirement, 
the corporation does not concern itself as to the nature 
or the volume of the business transacted by its members. 
They are free to do as much underwriting as they like, 
and may pursue any kind of insurance they choose, only 
they must do it honestly. As a consequence Lloyds, 
although marine insurance and the furnishing of maritime 
intelligence is the fundamental character of its business, 
is a place where one may insure against all sorts of con- 
tingencies — against fire, epidemics, sickness and all sorts 
of accidents, against the risks of journeys and business 

1 For a concise account of the organization of Lloyds and an excel- 
lent description of its system of classifying vessels and distributing 
marine intelligence, see Professor Gambaro's " Lessons in Commerce." 



12 YALE READINGS IN INSURANCE 

ventures, against the loss of works of art and valuable 
possessions, or to avoid loss from the unforeseen stoppage 
of games and races, or to meet contemplated changes in 
foreign tariffs, or to provide against the risks of war during 
periods of political excitement, and a hundred and one 
other contingencies of every conceivable kind, many of 
them nothing more than betting arrangements. Com- 
bining all these different forms of indemnity with the 
marine business, authorities place the total amount of 
risk carried at Lloyds at approximately $2,500,000,000, 
while the total deposits paid in by members as a guarantee 
for the performance of contracts are placed at not more 
than $20,000,000, or about only 1 per cent, of the risks 
assumed. 

In its daily routine of business Lloyds affords an inter- 
esting and instructive spectacle, and illustrates the com- 
plexity and arbitrary nature which surrounds a good share 
of the business. On the Exchange, for example, are 
several hundred underwriters, unincorporated and unable 
thus to act jointly. To describe the manner in which 
these members transact business, I can do no better than 
cite from Mr. Samuel Plimsoll's concise and picturesque 
account. "There are seldom," he says, "less than fifty 
underwriters on a policy, frequently over one hundred 
(the three policies before me show an average of seventy- 
two subscribers), not bound together at all, each indi- 
vidual can only act for himself, and accepts just so much 
of the whole risk as he pleases; he seldom, almost never, 
accepts for any large amount, always for a very small 
proportion indeed of the whole amount covered. The 
way of it is this : a member of Lloyds (underwriters' room) 
first gives evidence or security as to his ability to pay 
losses; then he has a desk allotted to him (they are very 
numerous — between three hundred and fifty and four 
hundred in London alone, where, however, the bulk of 
underwriting is done); the proposals of insurance are 
handed around by the insurance brokers' clerks all day 



HISTORY OF MARINE INSURANCE 13 

long; these proposals, called slips, give the name of the 
ship, amount to be insured, and rate per cent, offered. 
Perhaps sixty or seventy of these slips, or even more, are 
laid before each underwriter daily. After reference to 
Lloyds' List of Ships, he either passes it on or, if he de- 
cides to Hake a line' upon it, he subscribes or ' underwrites' 
his name, together with the amount he is willing to guar- 
antee for at the rate specified; this varies much and gen- 
erally goes as low as £200 or £100, frequently £50, and 
sometimes even less than that — never an amount large 
enough to warrant his disputing his liability in case of 
loss. 1 " 

As a result of the procedure thus described by Mr. 
Plimsoll, it follows that the underwriter at Lloyds has 
practically no opportunity to examine the risk as he would 
do in other leading forms of insurance. The only sources 
of information which he might use as a guide are, as a 
rule, the publications of the corporation, like the Annual 
Register } the Captain's Register, and Lloyds 1 List. From 
these he may obtain useful information concerning the age, 
size, structure, equipment and management of the vessel 
as based on frequent surveys by expert surveyors. But 
naturally such classifications have their limits, and do 
not purpose giving more than a general description of 
the vessel in question. Concerning many factors like 
stowage, the amount of load, the size and efficiency of 
the crew, and numerous other factors equally vital to the 
safety of a vessel and cargo at sea, these publications can 
offer no assistance. It is here that the insurer must use 
his judgment, and where success is largely dependent upon 
the specialized ability of the underwriter. Nor would 
it be to the interest of the insurer at Lloyds to make such 
an examination, assuming that he could do so. Not only 
will his limited time and the large number of proposals 
made to him daily render this impossible, but the mere 
fact that probably half a hundred other persons have 

1 Samuel Plimsoll. The Nineteenth Century, Vol. XXV, p. 329. 



14 YALE READINGS IN INSURANCE 

underwritten the same policy will make it seem foolhardy 
that he alone should undertake the examination. To 
retain his business he must be quick in accepting or re- 
jecting proposals on the spot, and can not afford to tarry, 
since it is the brokers' business to secure insurance for 
his patrons as quickly as possible. Moreover, the amount 
of the total risk, to which he has subscribed is, as we have 
seen, comparatively small and limited to an amount which 
will not make it worth his while to contest a claim or pur- 
sue an examination. And even if the underwriter be a 
subscriber for a large amount it does not necessarily follow 
that he will be actually liable for the amount underwritten, 
for as soon as he fears having sustained a loss he will en- 
deavor to transfer his risk. This he does by offering a 
higher premium as an inducement for some one else to 
take all or a share of his risk. One underwriter fearing a 
loss thus transfers part of his risk to another, who expects 
the early and safe arrival of the vessel. If uncertainty 
concerning the vessel continues, this second underwriter 
by offering a still higher premium may transfer part of 
his risk to another, who again has good hopes, and so on 
until, if it is finally learned that the vessel and cargo are 
lost, the risk has been so widely diffused that the loss 
incurred by any one individual is comparatively small. 
Lastly, it is interesting to note that collectively the under- 
writers at Lloyds have no interest in examining risks 
because they have no interest in diminishing loss. On 
the contrary, strange as it may seem, they express a pref- 
erence for a high rate of loss to a low one. Individually 
they all desire and expect to avoid the payment of claims, 
but collectively they all wish and expect to profit by high 
rates. Hence it is that they prefer the increase in pre- 
miums which accompanies an increase in losses. 

A review of marine insurance in the United States shows 
that its development as well as its present status is radi- 
cally different from that in England as just described. In 
the first place, the business has been conducted almost 



HISTORY OF MARINE INSURANCE 15 

altogether by corporations, the Lloyds system of under- 
writing, though often tried, having never obtained a pro- 
minent foothold in this country. Secondly, while British 
companies have had a long and prosperous career, the com- 
panies of the United States, with few exceptions, have 
either failed or changed the character of their business. 
If we are justified in fixing definite limits, the develop- 
ment of the business in this country seems to divide itself 
into four main epochs, each with distinctive character- 
istics of its own. The dates of these periods may be 
roughly placed at 1793 as marking the end of the first 
period, 1793 to 1840 as indicating the limits of the second 
period, 1840 to 1860 the third, and 1860 to the present 
time the final period. 

During the first period, extending to the end of the 
eighteenth century, the only form of insurance upon goods 
or vessels of which we have definite knowledge was by 
personal underwriters. Resort was had at first to the 
private underwriters of Great Britain, frequent mention 
being found in early colonial correspondence concerning 
London indemnity for American shipping. Even as late 
as 1721 there was as yet no insurance office in Philadelphia, 
dependence being placed mostly upon foreign under- 
writers. In that year we find a Mr. John Copson adver- 
tising in the American Weekly Mercury of May 25, the 
opening by him of an office of public insurance on vessels, 
goods, and merchandise, because, as he announced in the 
advertisement, "the merchants of this city of Philadelphia 
and other ports have been obliged to send to London for 
such insurance, which has not only been tedious and 
troublesome, but ever precarious, and for the remedying 
of which this office is opened." Four years later Mr. 
Francis Rawle, of Philadelphia, advised the establishment 
of a marine insurance office under colonial legislative 
sanction, and the pamphlet embodying his ideas was, 
according to report, the first work issued from Benjamin 
Franklin's press. Following Mr. Copson's and Mr. Rawle's 



16 YALE READINGS IN INSURANCE 

pioneer attempts to establish insurance offices, few efforts 
were made to follow in their footsteps. Mr. Fowler, in 
his history of insurance in Philadelphia, informs us that 
for seventy years afterwards Philadelphia merchants still 
looked to the Old World as the chief source from which 
to obtain their insurance. Likewise in New York City it 
was not until 1759 that the first marine insurance office 
was opened, and not until 1778 that the New Insurance 
Office was established. The underwriting in all these 
cases continued to be by individuals or partnerships only, 
who generally represented wealthy citizens of the com- 
munity. 

It was not until near the close of the eighteenth century 
that a number of citizens of Philadelphia succeeded in in- 
ducing the General Assembly of Pennsylvania to charter 
a marine insurance company, capitalized at $600,000. 
The reasons assigned for this step by the legislative com- 
mittee reporting in favor of granting the charter were: 
(1) That an incorporated company of this size could con- 
duct an insurance business on a safer and more staple 
basis than could individuals; (2) that from a legal point 
of view justice could be secured more readily in the case 
of a corporate organization, since it would obviate the 
expense and loss of time required to sue separately all 
the different underwriters to a policy; (3) that the num- 
ber of persons underwriting in Philadelphia was insufficient 
for the needs of its commercial interests, thus occa- 
sioning a drain of money for insurance to Europe and 
neighboring states; and, lastly, that since the company 
did not ask for a monopoly, the granting of the charter 
would simply mean the bringing about of a wholesome 
competition, and would enable the business to be conducted 
on an enlarged scale to the great benefit of commerce. 
In view of these reasons thus offered, the Assembly, in 
the year 1794, 1 chartered the Insurance Company of North 

1 The Insurance Company of North America began business as an 
association in 1792, and was incorporated in 1794. 



HISTORY OF MARINE INSURANCE 17 

America, the first stock company of its kind upon the con- 
tinent whose name it bore. Fortunately this pioneer 
company was launched at a time when Philadelphia was 
still the commercial metropolis of the country, with its 
ship-owners and merchants trading in all the remote quar- 
ters of the globe, and, therefore, large purchasers of insur- 
ance. Indeed it was not long before the brokers, who 
previously had had the American business to themselves, 
found that their patrons preferred the stability of cor- 
porate underwriting on a large scale to the underwriting 
of individuals. In the very first year of active business 
the company refused to write for private offices, and 
"realizing its strength, made public advertisement of 
their rules, and invited orders to be addressed directly 
to the company." 1 

This important step toward the establishment of cor- 
porate underwriting with all its advantages was soon to 
serve as a model for similar undertakings in other parts 
of the country, and before another decade had passed the 
Insurance Company of North America was to have active 
associates in its own home as well as in New York, Boston, 
Baltimore, Charleston, and other places. In 1796 was 
established the Insurance Company of New York in New 
York City, followed by the Associated Underwriters of 
the same city in 1797, the United in 1797, Columbian in 
1801, Washington Mutual in 1802, Marine in 1802, Com- 
mercial in 1804, Phoenix in 1807, Fireman's in 1810, 
Ocean in 1810, and others. In Philadelphia there followed 
the Insurance Company of the State of Pennsylvania 
in 1794, the Phoenix in 1803, the Philadelphia in 1804, 
Delaware in 1804, Marine in 1809, and the United States 
in 1810. Boston also came into the field at an early date, 
the Massachusetts Fire and Marine Company being organ- 
ized in that city in 1795, and the Boston Marine in 1799; 
while among other early companies of importance may be 
mentioned the Charitable Marine Society of Baltimore, 

1 "History of the Insurance Company of North America," p. 56. 



18 YALE READINGS IN INSURANCE 

organized in 1796: the New Haven Insurance Company, of 
New Haven, in 1797; the Charleston Insurance Company, 
of Charleston, S. C, in 1797, and the Newburyport Marine, 
of Newburyport, Mass., in 1797. So rapid, in fact, was the 
movement of incorporating insurance companies that prior 
to 1800 thirty-two insurance companies had been estab- 
lished in this country, of which ten were doing a marine 
business. By 1811 there existed in Philadelphia alone 
eleven companies, seven of which were marine companies 
and one a fire-marine company, while by 1825 there 
were twelve marine stock companies in New York, and at 
least a dozen in Boston. 

Prior to 1830 the history of these companies may be 
characterized as one of periodical prosperity and depression. 
If judged by the experience of the largest company (and 
this is typical of most other companies) the business ex- 
hibited the greatest fluctuations. Thus during the first 
decade of its history ending with December, 1802, the 
Insurance Company of North America collected premiums 
of $6,037,456 and paid losses of $5,500,887, leaving a margin 
of less than 9 per cent, for expenses. During this decade 
the premium receipts rose from $213,465 in 1793 to $290,656 
in 1794 and $1,304,208 in 1798. This large income, re- 
ceived by an American company prior to the beginning 
of the nineteenth century, it is interesting to note, is equal 
to three-fourths of the marine premiums received by the 
same company to-day, and exceeds the marine premium 
income of any other American company at the present 
time except one. Then began a decline, until in 1802 
the premium income amounted to only $103,902 which 
sum, however, was trebled in 1805, and again trebled in 
1806. Then came the Embargo Acts, and premium re- 
ceipts suddenly fell to the mere pittance of $5,483 in 1808, 
while losses continued as high as $108,568. Even in the 
years 1809 to 1812, inclusive, the average annual receipts 
equaled but $45,449, as compared with $1,304,000 in 
1798. If the decade ending in 1802 is compared with that 



HISTORY OF MARINE INSURANCE 19 

ending in 1812, it appears that the first shows premium 
receipts of $6,000,000 and losses of $5,500,000, while the 
second shows premiums of only $1,364,637, or only one- 
fifth the income of the first decade, and losses of $1,583,836. 

These remarkable fluctuations, as also the decrease in 
the annual premium receipts and the increase in the ratio 
of loss to income, are to be explained partly by the growing 
competition arising from the numerous rival institutions 
which were springing up everywhere; partly because in- 
surance managers had not yet mastered the lesson of a 
solid surplus and very imprudently distributed all profits 
to stockholders without making provision for the heavy 
losses of the immediate and stormy future; but mainly 
to the heavy losses connected with the Napoleonic Wars. 
This series of bitter struggles, with its blockades and 
counter-blockades, affecting practically all of commercial 
Europe, subjected American commerce to unusual risks 
and losses. Insurance was consequently in great demand 
and came for the first time to be regularly adopted by 
all ship-owners, and at rates which averaged as high as 
twelve per cent. But while the business of marine insur- 
ance received a strong impetus during this period of strife, 
the business was, nevertheless, of uncertain tenure, being 
constantly subject to the heavy losses arising from capture, 
detention, and litigation which frequently resulted, owing 
to the absence of a large surplus, in severely impairing 
the capital of the companies. Mr. Seyfert, for example, 
in a list compiled from a report of the Secretary of State, 
shows that the total captures of American vessels by the 
British, French, Neapolitans and Danes during the years 
1803 to 1812 aggregated nearly 1600 vessels, the major 
portion of which were condemned, and most of the others 
detained. At the same time we have the statement made in 
the House of Peers that 600 American vessels were seized 
or detained in British ports within a period of less than 
five months from November 6, 1793, to March 28, 1794. 1 

1 Adam Seyfert. "Statistical Annals of the United States," pp. 79-81. 



20 YALE READINGS IN INSURANCE 

Such extraordinary losses by capture and detention 
were bound to prove a heavy drain on the resources of 
the companies. And in those days of slow communica- 
tion it would often happen that they might be incurring 
heavy losses at the hands of foreign cruisers without being 
able to obtain knowledge of the same for months, in the 
meantime assuming new risks equally exposed to the 
attacks of the enemy. To obtain a clear conception of 
the losses thus sustained one need only examine the pro- 
ceedings of a few companies of this period. On February 
12, 1801, the directors of the Insurance Company of North 
America " ordered that an account of all illegal captures 
made by the British and French be made out for the pur- 
pose of representing the same to the United States 
Government." * No better evidence can be advanced to indi- 
cate the severity of the struggle which the early companies 
were undergoing than the account of the committee en- 
trusted with this work. Its report stated that "the number 
and amount of the companies' claims on the British Gov- 
ernment for spoliation on property which they (the com- 
mittee) think that nation ought to refund is about $981,355; 
other losses occasioned to this office by capture of the 
British, and for which there is no expectation of reimburse- 
ment, is about $78,800. With respect to the captures 
made by the French, your committee can only state that 
they amount to $1,952,730." 2 Many of the claims thus 
incurred were later adjusted by international arrange- 
ment. Others, however, were not, and numerous attempts 
were made in later years to recover losses sustained during 
this period. No less than twenty-two reports of commit- 
tees, all favoring the claimants, were made in Congress 
between the years 1827 and 1846 for an indemnity of 
$5,000,000. Twice, in 1846 and 1855, did the bills pass 
through all stages of enactment except the President's 
signature, and even as late as 1885 we find the matter still 
before Congress. 

1 "History of the Insurance Company of North America," p. 56. 
HUd. 



HISTORY OF MARINE INSURANCE 21 

With the cessation in 1815 of the widespread Napole- 
onic Wars of twenty-three years and the introduction of 
a period of profound peace one might have supposed that 
the business would have immediately revived. But such 
was not the case. The high war rates gradually gave 
way before low peace rates, and by 1820 these were the 
general rule. By this time, too, personal underwriters 
had been almost entirely displaced by underwriting cor- 
porations whose number had greatly multiplied in all the 
leading seaports. To make matters still worse, in view 
of the rapidly declining rates, these numerous corporations 
began to wage a fierce and incessant competitive war 
against each other. The elimination of the personal 
underwriter meant the establishment of the broker as 
middleman, and soon the numerous companies in the 
various leading commercial centers no longer confined 
their business activity to their own locality, as they had 
done heretofore, but began to solicit risks from the outside 
by correspondence and otherwise. As a result of this 
rate war, many of the younger companies were brought 
to the verge of insolvency, and most of the older ones were 
unable to pay dividends on their capital equal to the 
current rate of interest. So great was the competition 
that at the close of 1825 the stock of only four of the 
twelve stock companies in New York was quoted at or 
above par. Beginning with 1828 marine insurance com- 
panies were also obliged to pay extraordinary losses occa- 
sioned by fraudulent wrecks on the Atlantic, Gulf, and 
West India coasts. Estimates place the losses incurred 
in this way at one-third of the total loss sustained by com- 
panies during the twenty years preceding 1840. 1 It was 
not till 1844 that the companies of Philadelphia, for ex- 
ample, managed to organize a protective association 
through whose action these heavy losses by fraud could 
be averted. 2 

1 Albert Bolles. "Industrial History of the United States," p. 820. 

2 Ibid. 



22 YALE READINGS IN INSURANCE 

Beginning with the fifth decade, the business again 
showed signs of gradual revival, and the twenty years 
following 1840 may be justly characterized as the "golden 
period" of American marine insurance. It was during 
these years that the American clipper ship received its 
highest development, and became probably the most 
efficient carrier in the world. Our tonnage in the foreign 
carrying trade increased from 762,838 registered tons in 
1840 to 2,496,894 tons in 1861, the highest point ever 
reached in our history, and a tonnage nearly two and one- 
half times as large as the largest tonnage registered for 
any single year prior to 1840. Along with this remarkable 
increase of 1,734,056 tons in twenty years, American 
vessels continued during these two decades to carry on 
an average 70 per cent, of the combined imports and 
exports of the country, the proportion in some years 
running as high as 81 to 83 per cent. It was also during 
this epoch that American trade with the Far East and 
other remote parts of the globe became more prominent 
than ever before. Unlike the practice in modern com- 
merce, the merchants in those days were largely the owners 
of the ships which carried their cargoes, and naturally 
they insured both in American companies. The voyages, 
as a rule, were long, extending in many cases over six 
or nine months before the vessel was heard from. The 
risk was thus very considerable, insurance was an indis- 
pensable necessity greatly desired, and rates ranged as 
high as five to six per cent. We are told that even be- 
tween New York and Liverpool the rate on dry goods 
was as high as 2 per cent, compared with the existing 
rate of between one-eighth and one-tenth of 1 per cent, 
on our modern steamers. All these factors — increasing 
commerce under American ownership, long voyages of 
a risky nature, and high rates — combined to give to 
marine insurance during this period an impetus such as 
it had never experienced before. 

But this period of unparalleled growth proved to be 



HISTORY OF MARINE INSURANCE 23 

but temporary, and was followed by an epoch, extending 
to the present, as disastrous to the business as the pre- 
ceding period had been beneficial. For many years 
marine insurance had kept in the forefront of our com- 
mercial life, and could indeed be ranked with fire insur- 
ance in importance. It began to show unmistakable 
signs of decay, for reasons to be mentioned shortly, when 
the American flag began to vanish from the sea. This 
decline has been continuous and unchecked. In fact, 
during the last thirty-five years marine insurance by 
native companies has had to struggle for its life. How 
severe this struggle has been, and how severely the busi- 
ness has suffered may be inferred from the fact that 
since the organization of the first company in New York, 
in 1796, some thirty companies have been chartered in 
that state, and of this number only three, the Atlantic 
Mutual, the Home, and the Greenwich Insurance Compa- 
nies, still continue to do business. To recite the his- 
tory of the business in our other commercial states is 
merely to repeat its history in New York. In all ma- 
rine insurance once flourished, but in all it has largely 
disappeared. 

But why this decline? it will be asked. The answer 
is that two main causes have contributed, namely, com- 
petition of foreign companies, and changed business con- 
ditions. Owing principally to the introduction by England 
during the fifth and sixth decades of the last century of 
iron as ship-building material and coal as fuel, just at 
the time when the United States had not yet developed 
its iron and coal resources, and when the attention of the 
country was turned away from the sea to the development 
of the interior, the American wooden ship, which up to 
this time had been an important factor in international 
trade, began for the first time to feel seriously the effects 
of foreign competition. Immediately following the intro- 
duction of the iron steamship by England came the Civil 
War, with its heavy losses for marine companies, with 



24 YALE READINGS IN INSURANCE 

its heavy taxation of American commerce, with the al- 
most complete cessation of the important cotton trade 
and the trade with the Southern States, with the capture 
and destruction of Union ships by Confederate cruisers, 
with the transfer by sale of a large portion of American 
tonnage to foreign countries, and, in general, the complete 
demoralization of American shipping. The direct effect 
of these various factors, growing out of the Civil War, 
upon our marine insurance companies can scarcely be 
over emphasized. To illustrate how the prosperity of the 
business in the preceding period vanished shortly after 
the commencement of hostilities, we can do no better 
than consult the annual reports of the New York Insurance 
Department, since the experience of the companies here 
is but typical of that in other states. In the report of 
1862 the superintendent of insurance states "that the 
disorders and complications resulting from the insurrec- 
tion of several states during the last year have necessarily 
affected to a considerable extent the business of our marine 
companies; but an examination of their statements will 
show that the well-established reputation of our marine 
underwriters is enhanced by their successful transit over 
this ever memorable year. With the single exception of 
the Anchor no failures have occured among the companies. ' ' 
In the report of 1863 we again find that "not a single 
company is blotted out." But the companies could not 
continue to fight successfully against overwhelming mis- 
fortunes. In 1864 we note that two important companies 
failed; and in 1865 occurred the failure of the Columbian, 
with outstanding unpaid losses of $3,470,000. According 
to the report for 1865 the incomes of the marine insurance 
companies in New York showed that only one of the eleven 
companies in the state received more than it expended 
during the year, the total net excess of expenditures over 
income being $1,458,309, not counting the heavy losses of 
the Columbian. While the ratio of marine and inland 
losses paid to premiums received in the United States in 



HISTORY OF MARINE INSURANCE 25 

1904 amounted to but 47.43 per cent., that ratio rose to 
71.64 per cent, in 1865 (not including the losses of the 
Columbian), and to the extraordinary ratio of 83.13 per 
cent, in 1866. Although the premiums in 1866 were in- 
creased $3,223,199 over the year 1865, the losses exceeded 
those of 1865 by $3,938,606; while the gross expenditures 
of the companies exceeded the gross income in the sum of 
$1,243,000, thus causing the superintendent of insurance 
to report that "the present fearful percentage of loss is 
too excessive and must in some manner be reduced, and 
not merely covered by insurance." Before business con- 
ditions could again become stable, the number of marine 
insurance companies in New York had been reduced by 
failures from fourteen (the number in 1861) to nine in 
1867, while nearly all which survived were no longer the 
prosperous companies of the preceding decade. 

But there were also indirect effects growing out of the 
Civil War and the competition of the iron steamship' quite 
as important as those just mentioned. All the factors 
enumerated above, coming in close succession and at a 
most critical time, gave Great Britain the opportunity, 
which she was only too quick to seize, to monopolize the 
construction and operation of the world's shipping. As 
a consequence, the tonnage of the United States engaged 
in foreign trade has gradually declined to 888,628 tons 
in 1904, or only one-third of what it was in 1861. While 
the United States carried 75 per cent, of our total imports 
and exports in its own ships during the two decades from 
1840 to 1861, that proportion has steadily declined until 
it is less than 8 per cent, to-day. 

Now, hand in hand with the steady decay of our mer- 
chant marine after the war, there followed a correspond- 
ing decline in the magnitude and prestige of the marine 
insurance business. Great Britain was capturing the carry- 
ing trade of the world, and British merchants and ship- 
owners were just as naturally giving their patronage to 
their own underwriters, as American merchants and ship- 



26 YALE READINGS IN INSURANCE 

owners had insured in American companies while our 
trade was still in its glory. 

But British underwriters were doing more than merely 
acquiring business which formerly had gone to American 
companies. They were consciously pursuing a policy, 
whether justly or unjustly it is not our purpose to state, 
which aimed to give preference to their own flag on the 
sea through inspection and classification at Lloyds, and 
through these channels the fixing of insurance rates. The 
essential features of this policy may be enumerated as 
follows: 

(1) To grade vessels not so much with reference to their 
design and sea-going capacity, as according to their in- 
trinsic quality as measured largely by the cost of construc- 
tion and repairs. This meant discounting the sea-going 
worth of the American clipper ship. 

(2) To favor British-built vessels and British ship- 
building materials in the matter of inspection and classi- 
fication. One writer even goes so far as to state that 
" nothing ' foreign ' has ever received the highest rating 
from Lloyds.'' * Especially in the rating of timber for ship- 
building purposes has this policy manifested itself most 
clearly. At no time has American timber been graded 
the same in years as timber of British origin, the best 
white oak of the United States being allowed but two- 
thirds of the time given to British oak. From the begin- 
ning, too, Lloyds has observed the rule not to grant a 
full class to any vessel unless the date and place of building 
is announced, and the construction has taken place under 
survey. At the same time, even before iron ship-building 
began in England, Lloyds never appointed surveyors to 
inspect the construction of foreign wooden vessels. 

(3) To protect and foster metal and steam tonnage and 
to make the British iron steamship, the construction of 
which was for many years practically monopolized by 
Great Britain, the standard in international trade. Such 

1 William W. Bates, "American Navigation," p. 303. 



HISTORY OF MARINE INSURANCE 27 

a policy was bound to hasten the decline of American 
shipping. Underclassing the American wooden ship by 
Lloyds meant in actual practice a very considerable de- 
crease in the chances for speedy and profitable employ- 
ment. In 1870, Lloyds refused to classify and register 
foreign wooden vessels except on special survey and for 
a period not exceeding one year. The object was to 
encourage the chartering of British vessels in preference 
to wooden ships, and the effect of the rule was to obtain 
for Great Britain a large part of our carrying trade. 

Evidence seems to show that marine underwriting has 
not declined in the United States because American com- 
panies have failed to meet the rates of foreign under- 
writers. Instead, the decline must be attributed to the 
decay of our merchant marine engaged in foreign trade, 
and among the numerous causes mentioned as instru- 
mental in bringing about this result, the policy of Lloyds 
must be classed as one. As Mr. Bates says: "It was rare 
indeed that a British policy covered an American hull. 
The purpose was to mark the American ship with inferi- 
ority in the Register, thereby to prevent ready employment 
and full rates of freight. And yet, in order to get cargoes 
that were bound to be covered by British insurance, it 
was necessary to hold a class of some grade in Lloyds' 
Register" 1 Whatever the purpose of the various regula- 
tions adopted by Lloyds may have been, whether based 
justly on the relative merits of vessels or not, they did, 
at a most critical period in the history of our merchant 
marine, represent American ships to the world as an 
inferior type, did contribute toward the decline of the 
American marine by decreasing its chances of profitable 
employment, and by helping thus to transfer the carry- 
ing trade from the United States to Great Britain, did 
contribute to the growth of marine insurance abroad and 
toward its decline here. 

Foreign underwriters, however, were not satisfied with 

1 William W. Bates, "American Navigation," p. 305. 



28 YALE READINGS IN INSURANCE 

getting the American business that came to them at home, 
but began in the early seventies to invade American terri- 
tory itself. To ascertain the rapidity of this movement 
we may again consult the insurance reports of New York, 
the experience here being typical of that in other leading 
commercial states. In the report of 1868 the superin- 
tendent of insurance states that "no foreign marine 
insurance companies have ever been admitted by this 
department to transact business in the State of New York" ; 
while the report for 1871 shows only one foreign company 
as compared with nine New York companies. By 1872, 
however, there were four foreign marine companies trans- 
acting business in New York; while by 1874 the number 
had increased to seven. This increase in the number of 
foreign companies has continued, so that while to-day 
there are only three New York companies of any impor- 
tance transacting marine insurance in that state, there 
are fifteen foreign companies. 

In entering American territory foreign companies were 
materially assisted by the lenient laws of some of our 
states requiring of foreign companies, as a prerequisite 
for admission, a deposit equal only to the minimum capital 
demanded of domestic companies. They began their 
onslaught by cutting rates, and the American companies, 
probably too few in number by this time or otherwise 
unable to effect an efficient combination in opposition, 
were compelled to follow suit. Then began a period of 
the most active competition between domestic and foreign 
companies, the result of which, in view of the other un- 
favorable attending circumstances already mentioned, 
meant the gradual forcing of American companies out of 
existence. 

In this competition the foreign competitors had the ad- 
vantage of the much better organization and the much 
greater financial strength acquired at home during their 
much longer existence, and could, therefore, afford to 
assume much larger risks based on their home capital. 



HISTORY OF MARINE INSURANCE 29 

The small American companies, on the contrary, though 
their assets might be considerably in excess of the assets 
actually held by foreign companies in this country, were, 
nevertheless, for the reason mentioned above, limited to 
a much smaller aggregate of risks. To distinguish be- 
tween the efficiency of the two classes of companies in 
this respect one need only examine the data concerning 
foreign companies as given in the Insurance Year-Book. 
Of twenty-seven leading British marine companies men- 
tioned here in 1902, twenty, or three-fourths, confine 
themselves solely to the writing of marine risks, while 
in the United States nearly all companies transacting a 
marine insurance business place their greatest reliance 
upon the fire insurance branch of their business. More- 
over, most of the early American companies have ceased 
doing business and only a few (the leading ones) have had 
a long and continuous existence. In the United Kingdom, 
on the contrary, of the twenty-seven companies referred 
to, eight were organized prior to 1837, three considerably 
before the beginning of the nineteenth century, and all 
except four have had an existence of at least a quarter 
of a century, and most of them much longer. During 
this long and, on the whole, prosperous existence these 
companies have accumulated enormous assets, thus giv- 
ing them an advantage over American companies, a fact 
which becomes clear when we reflect that the eight prin- 
cipal English companies doing business in the United 
States to-day have assets at home exceeding $50,000,000. 
"The financial position of nearly all the British marine 
companies," according to the Insurance Supplement to 
The Statist, 1 "is of such strength that even an unusually 
long period of adversity could be faced with equanimity. 
By a long process of limiting dividends they have acquired 
funds so large that policy-holders are most adequately 
secured, while at the same time the interest earnings are 
sufficient, or nearly sufficient, to provide for the main- 

1 Supplement to The Statist, May 6, 1905, pp. 27 and 28. 



30 YALE READINGS IN INSURANCE 

tenance of the present rate of dividends. Thus even very- 
moderate trading profits are amply sufficient steadily to 
increase the financial security. ... To show the great 
and increasing financial strength of the marine insurance 
companies it should be noted that the accumulated funds 
have increased 38 per cent, during the decade 1893-1903, 
the premium income has only risen 14 per cent, and the 
proportion of the former to the latter has risen from 177 
to 217 per cent. Thus the invested funds represent over 
£2 for every £1 annually received from policy-holders, an 
exceedingly satisfactory position from all points of view. 
... In fact, the financial position of most of the offices 
is so strong that temporary profit fluctuations may be 
disregarded, and in many cases present dividends could be 
maintained even if the companies undertook no more 
business whatever." 

The truth of the above summary is borne out by a con- 
sideration of the dividends paid and the interest earnings 
of the thirteen principal British companies (nearly all of 
which operate in the United States) during the years 1901 
to 1904. The last three years of this period have been 
marked by a severe depression in the shipping industry, 
and consequently marine profits have been below the 
average. Yet the annual dividend of only two of these 
companies averaged as low as 6 and 7.5 per cent., respec- 
tively, during the period; in six companies it averaged 
between 10 and 20 per cent.; in four between 20 and 40 
per cent.; and in one 44.5 per cent. In eight companies 
the average annual interest earnings on the accumulated 
funds exceeded the large dividends paid, and in the re- 
maining five were nearly as large. Moreover, the average 
annual surplus of these companies, after deducting from 
the net premium income of the year the actual losses paid, 
all expenses, dividends, and appropriations to the sus- 
pense account, aggregated $1,708,000. A financial show- 
ing of this kind is especially significant since fluctuations 
in income are inevitable in a business like marine insurance 



HISTORY OF MARINE INSURANCE 31 

where the rates and the amount of business, roughly speak- 
ing, rise and fall with the prosperity or depression of the ship- 
ping industry, the most sensitive to changing industrial 
and political conditions of any large industry in the world. 
English companies are to-day our main competitors, but 
companies of other countries, notably Germany and 
Canada, are entering the ranks against us. Even on the 
Pacific coast nineteen foreign companies, unknown to 
other sections of the country, are doing business, repre- 
senting England, Germany, France, Italy, Switzerland, 
China, and Japan. 

The extent to which foreign companies have acquired 
control of marine insurance in the United States becomes 
especially clear if one examines the annual financial reports 
of the various companies. If a compilation is made of 
the statistics as found in these reports, it will appear that 
for the year 1903 the total net marine risks assumed by all 
the foreign and domestic companies operating in the 
United States aggregated approximately $6,877,006,221, 
the net premiums received nearly $18,000,000, and the 
admitted assets $112,912,000. Of these amounts the 
American branches of the twenty leading foreign com- 
panies (to say nothing of the large number of foreign 
companies operating on the Pacific coast) wrote $3,723,- 
000,000 of the risks, or 54 per cent, of the total, received 
$7,160,335 of the net premiums, but possess only $21,733,- 
958, or less than one-fourth of the admitted assets. Most 
of these foreign companies also confine themselves solely 
to the writing of marine risks, only six of the above 
twenty companies transacting a fire business in addition 
to their marine business. 

Strikingly different is the situation as revealed by the 
statistics collected from the reports of American fire and 
fire-marine companies. Thus, there are at present thirty- 
one domestic marine and fire-marine companies operating 
in the United States, writing approximately $3,153,000,000 
of net risks, collecting $10,703,000 of net premiums, and 



32 YALE READINGS IN INSURANCE 

possessing $91,178,000 of admitted assets. Yet of this 
large number of companies, it must be remembered that 
the two largest, the Insurance Company of North America 
and the Atlantic Mutual of New York, write over one- 
third of the total risks assumed by American companies 
($1,220,000,000), collect nearly one-half of the total pre- 
miums ($5,180,682), and possess one-fourth of the total 
assets ($23,285,000). Considering the eleven largest do- 
mestic companies, comprising only one-third of the total 
number, it appears that they write 82 per cent, of the 
total risks, and own 83 per cent, of the total assets. The 
remaining companies are of so little significance from a 
marine insurance standpoint that they may be eliminated 
for all practical purposes, a fact which becomes apparent 
when it is remembered that fourteen of these companies 
combined collected only $83,592 in premiums in 1904. 

Unlike the foreign companies operating in the United 
States, the domestic companies depend much more largely 
on a fire insurance business in conjunction with their 
marine business. Only five of the thirty-one domestic 
companies devote themselves exclusively to marine insur- 
ance, and of these five companies only two can be classed 
as important. All the other companies combine a fire insur- 
ance business with the marine business, and almost without 
exception place much greater emphasis upon the former 
than upon the latter. Thus of the twenty-six domestic 
fire-marine companies only two do a larger marine than 
a fire insurance business; in two other companies the 
marine and inland business is only 34 per cent, and 45 per 
cent, as large as the fire insurance business; in three only 22 
per cent, to 27 per cent, as large; in two only 11 per cent, and 
16 per cent. ; and in all the remaining companies less than 
7 per cent. Combining the business of all the domestic 
marine and fire-marine companies, it appears that they 
carry nearly three times as much fire risk as marine and 
inland risks, and receive nearly four times as much in 
premiums from their fire as from their marine and inland 



HISTORY OF MARINE INSURANCE 33 

business. Indeed, there are many fire insurance companies 
in the United States to-day whose names clearly indicate 
that they were at one time fire-marine companies and 
whose charters originally entitled them to transact a 
marine insurance business, but which have ceased alto- 
gether to underwrite such risks. Moreover, upon inquiry, 
it was learned from a considerable number of companies 
that their marine business has been and is decreasing in 
volume owing to the fact that large foreign marine com- 
panies insure entire ship cargoes, leaving only small amounts 
to be picked up by the smaller companies. Other com- 
panies continue to carry each year a small amount of 
insurance of from several hundred to a few thousand 
dollars in premiums for the sole purpose of keeping alive 
that part of their charter which permits them to write 
marine insurance. 

Continuing our investigation still further, it appears 
that the business of the foreign companies operating in 
the United States is by no means limited to any particular 
section of the country, but is general throughout. In the 
Eastern coast states of Massachusetts, New York, Penn- 
sylvania, and New Jersey, where over one-half of the 
country's total marine insurance is transacted, the busi- 
ness is divided nearly half and half between domestic and 
foreign companies. Domestic companies wrote in 1903 
54 per cent, of the total risks and earned 65 per cent, of 
the net premiums, the greater part of the insurance being 
for hulls and cargoes of American vessels engaged in the 
coastwise trade. The business of foreign companies, on 
the other hand, representing 46 per cent, of the risks and 
35 per cent, of the premiums, consists in very large measure 
of insurance on the cargoes of foreign vessels engaged in 
our foreign trade. 

But foreign companies have by no means confined their 
activity to our Eastern coast, as might at first be supposed, 
but have boldly extended their business into the interior 
of the country, until to-day they control the greater part 



34 YALE READINGS IN INSURANCE 

of the marine insurance business of the Great Lake region. 
This becomes apparent upon an examination of the insur- 
ance statistics as published by the insurance departments 
of Ohio, Michigan, Illinois, Wisconsin, and Minnesota. A 
tabulation of these statistics shows that the nine principal 
American companies operating in these states (and they 
transact nearly all the business done by American com- 
panies), wrote $160,345,676 of marine risks in 1903; the 
local companies of these five states wrote only $5,394,358; 
while the thirteen foreign companies which have entered 
these states wrote $249,711,561. In other words, of the 
$405,450,000 of marine risks assumed by all companies 
in the Lake region, foreign companies wrote 61.5 per cent, 
and received 53 per cent, of the total premiums collected. 

In the Gulf region the influence of foreign companies is 
still more apparent, judging from the experience of the 
three leading commercial states of Alabama, Louisiana, 
and Texas. In 1904 the marine insurance business trans- 
acted by all companies in these states aggregated $308,- 
508,895 of risks and $1,648,000 of premiums. Of this 
business the local companies wrote only 4 per cent., while 
all American companies combined represented consider- 
ably less than one-fourth. Foreign companies, however, 
representing England and Germany, wrote over 75 per 
cent, of the risks and received nearly 83 per cent, of the 
total premiums. 

What has been said concerning the gradual control of 
marine insurance by foreign companies on our Eastern 
coast and in the Lake and Gulf regions is true to an even 
greater extent on the Pacific coast. As illustrative of the 
situation here, California may be taken as the example, 
since over four-fifths of the insurance on the Pacific coast 
is written in this state. Thus a review of the last report 
issued by the insurance department of California shows 
that in 1903 forty-six companies were transacting a marine 
insurance business in that state, and that of this large 
number only seven were American companies, while 



HISTORY OF MARINE INSURANCE 35 

thirty-nine represented foreign countries, nine being 
located in London, seven in Liverpool, seven in the leading 
ports of Germany, four in Hong Kong, three in Switzer- 
land, two in Australia and New Zealand, two in Canada, 
two in Shanghai and one each in Paris, Tokio, and Milan. 
Of the $210,500,000 of marine risks written in California 
in 1903, only $31,500,000, or 15 per cent, of the total, was 
written by California companies, and only $11,500,000 or 
5.5 per cent, by companies of other states. On the other 
hand, the companies representing foreign countries wrote 
$167,499,372 or 79.5 per cent, of the total risks, and col- 
lected 73 per cent, of all the premiums paid. Even in 
the State of Washington where the aggregate risk assumed 
by marine companies is as yet very small (only $18,069,683 1 
in 1903), and where two Western companies, 2 the only 
American companies in the state, have had control of 
most of the business, eight foreign companies, repre- 
senting England, Germany, Switzerland, and Canada wrote 
nearly one-third of the business in 1904. These statistics 
show conclusively that the vast bulk of the marine insur- 
ance business on the Pacific coast is now controlled by 
foreign capital, and that American companies have gradu- 
ally been forced out of business through undue competi- 
tion. Local insurance capital and earnings have always 
been invested in buildings, mortgages, bonds, etc., of the 
state, subject to taxation, while foreign capital for many 
years, as President Fowler, of the Insurance Company of 
San Francisco, said in substance in 1891, "entered the 
State of California without any deposit or security to pro- 
tect the policy-holders, sending its earnings to the head 
office, and not contributing one dollar toward the expenses 

1 In addition to this amount marine brokers transacted $3,591,485 
of business for unauthorized companies during the year 1904, thus 
giving $21,661,168 of net risk for the State of Washington in that 
year. 

2 Fireman's Fund Insurance Company (of San Francisco) and St. 
Paul Fire and Marine Insurance Company. 



36 YALE READINGS IN INSURANCE 

of the state and national government, thus transacting 
business in California upon more favorable and advan- 
tageous terms and conditions than local capital." * Under 
such circumstances, President Fowler points out, that it 
is not to be wondered at that by 1891 twelve California 
companies, with a paid-up capital of $5,600,000 and with 
annual fire and marine premiums of $10,000,000, had 
either failed or retired from business; 2 and this decrease 
in the number of local companies, be it noted, has con- 
tinued so that while there were five California companies 
still in operation in 1891, that number has declined to 
only two in 1903. Moreover, most of the companies to 
which President Fowler referred had reinsured in foreign 
companies with the result that upon their retirement their 
business simply helped to increase the large volume of 
business already transacted in the state by foreign com- 
panies. 

But while the number of foreign companies on the 
Pacific coast and the volume of their business has increased 
at the expense of domestic companies, it should be noticed 
that, despite the increasing importance of San Francisco 
and other Pacific ports, marine insurance as transacted 
by insurance companies, has, as a whole, shown little 
tendency to increase for the last twenty years for the 
reason, as pointed out by the Insurance Commissioner of 
California, "that nearly all of the steamship companies 
owning vessels plying in and out of San Francisco are 
organized and controlled outside of the state, and the 
tendency of these corporations is either to carry their own 
insurance or place it outside of the State of California, 
while the coasting fleet is running practically without 
insurance. In addition much of the Oriental business 
is from and with Atlantic ports and is insured on the 
Atlantic side." 

1 For President Fowler's remarks, see William W. Bates' "American 
Marine," pp. 290-291. 
*lbid. 



HISTORY OF MARINE INSURANCE 37 

Viewing the marine insurance business of the United 
States in its entirely, it is clear that domestic companies 
are to-day entirely unable to meet American requirements. 
On the Eastern coast foreign companies claim nearly one- 
half of the business. The same is true to an even greater 
extent in the Lake region; while in the Gulf States and on 
the Pacific coast approximately four-fifths of the business 
is controlled by foreign capital. Even in our coastwise 
trade, the one branch of our commerce from which for- 
eigners have been excluded by statute for nearly a century, 
the largest buyers of insurance place it almost half and 
half between domestic and foreign companies. Evidence 
before the United States Industrial Commission tends to 
show that the home market soon becomes exhausted, and 
that it is the practice of the principal shipping companies 
to take all the American insurance they can obtain, and 
to depend upon foreign underwriters for the rest. 

Recently there has also been a marked tendency toward 
self -insurance. The International Mercantile Marine Com- 
pany, for example, embracing some of the largest steam- 
ship lines leaving the port of New York, announces in its 
report of December 31, 1903, that "the company has 
inaugurated a system of insuring its own ships to a large 
extent, it being deemed that this could be done advan- 
tageously and safely with such a large fleet as the company 
commands." (138 ships.) Under this system an insurance 
fund has been established into which gross premiums were 
paid in 1903, amounting to $2,100,523 and against which 
all losses and premiums paid for additional insurance are 
charged. The insurance department of the company in- 
sures the vessels owned by the company against all the 
marine risks usually covered by insurance companies, at 
the market rate for the various services. It also insures 
the risks on freight and passage money in connection with 
its own business, and follows the custom of underwriters 
in placing with regular insurance companies for its own 
protection a portion of certain large risks which it has 



38 YALE READINGS IN INSURANCE 

assumed. The premiums paid in by the various steam- 
ship lines are placed on separate accounts with two bank- 
ing houses, one in London and one in New York, and thus 
kept distinct from the company's operating transactions. 
While this is the most notable recent example of self- 
insurance, it should be remembered that this method was 
practised on a large scale many years ago. As early as 
1867, we are informed by Mr. Hopkins, in his work on marine 
insurance of that date, that the Peninsular and Oriental 
Steamship Company possessed not only an insurance sys- 
tem for its fifty-three large steamships, but also insured 
its passengers, baggage and effects, and issued policies on 
goods. I am informed by the managers and officers of 
the largest steamship lines that self-insurance is prac- 
tised extensively by their companies in one form or another. 
While the coastwise lines and the smaller trans-oceanic 
lines depend almost entirely upon marine insurance com- 
panies for their insurance, it is a fact that in the case of 
such lines as the great German steamship companies nearly 
all the insurance is carried by the companies themselves. 
It is the general rule, however, followed by the German 
lines as well as the International Mercantile Marine Com- 
pany, that they refrain from insuring the cargo, and permit 
this risk to be covered by marine insurance companies. 



CHAPTER II 

THE POLICY CONTRACT IN MARINE INSURANCE 1 

The more direct introduction of marine insurance in the 
British Isles was by the Lombards, who settled in that 
country in the fourteenth century. In London they were 
the great money lenders, and were then known as usurers. 
They combined with their business of banking the prac- 
tice of marine insurance. The form of "policy" now 
used appears to have been introduced by them from Italy. 
The name denotes Italian origin and is supposed to mean a 
promise. The policy, being thus brought down from medi- 
aeval times, partakes largely of the quaint language of an 
early period. An English judge pronounced it "an absurd 
and incoherent instrument. But it has obtained a clear 
and definite meaning through a prolonged series of judi- 
cial decisions." Almost every word of it has been weighed 
in the judicial balance and assigned its proper value. 
Reference is made to the remarks made by Mr. Justice 
Blackstone in his celebrated Commentaries: "The learn- 
ing relating to marine insurance has of late years been 
greatly improved by a series of judicial decisions which 
have now established the law in such a variety of cases 
that if well and judiciously collected they would form a 
very complete title in a code of commercial jurisprudence." 2 

Some changes have been introduced into the form of 
policy used in the United States, but the original enumera- 

1 By A. A. Raven. Lecture at Yale University, February 22, 1904. 
Reprinted from pages 177-203 of the " Yale Lectures on Insurance, 
Fire and Miscellaneous," 1904. 

2 Martin on the "History of the Lloyds." 

39 



40 YALE READINGS IN INSURANCE 

tion of the perils insured against has been retained and, 
I believe, is used by all marine insurers. Too much time 
would be required to give a complete analysis of the policy, 
but a few reflections may be necessary to throw light upon 
the part relating to the risks assumed by the insurer. 
As respects that part of the contract, the policy reads : 

"Touching the adventures and perils which the said 
insurer is contented to bear and takes upon itself, in this 
voyage, they are of the seas, men of war, fires, enemies, 
pirates, rovers, thieves, jettisons, letters of mart and coun- 
ter-mart, reprisals, takings at sea, arrests, restraints 
and detainments of all kings, princes, or people of what 
nation, condition or quality, soever, barratry of the master 
and mariners, and all other perils, losses, and misfortunes 
that have or shall come to the hurt, detriment or damage 
of the said goods and merchandise or any part thereof." 
The perils thus enumerated are used synonymously with 
the losses arising from them. 

The originators of the policy evidently had in mind 
serious perils to which maritime ventures were exposed 
from the violence of man, both as a marauder and in the 
exercise of warlike operations which in early times, in the 
latter case, were almost perpetual. It is not to be won- 
dered at that they were thus apprehensive. Piracy and 
buccaneering did not cease with the dawn of a higher 
civilization, nor were such practices restrained, but con- 
tinued even when the mediaeval spirit had given way to 
nobler purposes in other respects, for we find that as late 
as in the reign of Queen Elizabeth of England, that sover- 
eign recognized the exploits of a noted marauder and 
conferred upon him the honor of knighthood. 

Letters of Mart and Counter-mart. — The first is author- 
ity to make reprisals on an enemy's property. Com- 
missions were given by governments at war to private 
vessels to make such reprisals on the high seas, and the 
practice is commonly designated privateering. Letters of 
counter-mart represented a similar authority to private 



MARINE INSURANCE POLICY 41 

expeditions to resist those empowered to make captures 
through letters of mart. Both of these came under the 
risk of war. By the declaration of maritime law adopted 
at the Congress of Paris in 1856, this system of preying 
upon an enemy's property upon the high seas by privateers 
was abolished. The United States and Spain, however, 
did not concur in the declaration. 

Barratry of the Master and Mariners. — The word bar- 
ratry appears to have been derived from the Italian "bar- 
ratatore," meaning fraudulent dealing, fraud, etc., and 
represents all dishonest practices whereby the ship-owner 
or others interested are defrauded. The ship may be 
wrecked, fired, or abandoned with fraudulent intent. It 
is to be observed that to constitute barratry under an 
insurance the owner must not be privy to nor cognizant 
of the act. Formerly barratrous acts were quite com- 
mon, but in recent years they have become rare in their 
heinous form. 

The scope of the policy, it will be noticed, is exceedingly 
broad and the terminal expression, "and all other perils, 
losses, and misfortunes, that have or shall come to the hurt, 
detriment, or damage of the said goods, and merchandise 
or any part thereof" would indicate a further broadening 
of the contract, so as to include all possible perils; but the 
real intent and meaning of the policy does not include any 
other perils than those of the sea, and the losses for which 
the insurer assumes liability are those which are caused 
from those perils through fortuitous or overpowering cir- 
cumstances and not by any inherent defect in the subject 
insured. This latter is legally termed "vice propre," as 
for example, any article that during the ordinary course 
of transportation necessarily becomes deteriorated by the 
inevitable result of defects in itself. Such losses are 
not recoverable in marine insurance. It will be observed 
that hazards named "perils of the sea," and which are 
contemplated as a marine venture, are those resulting 
from the violent action of the elements, — all casualties 



42 YALE READINGS IN INSURANCE 

as distinguished from the ordinary undisturbed prosecu- 
tion of the voyage. The original form of policy did not 
provide any limit as to the liability of the insurer. In 
the course of time, experience demonstrated the necessity 
of limiting his burden and excluding from the policy 
liability for losses arising from natural causes as before 
referred to. In the year 1749 a committee of Lloyds, 
London, decided upon the introduction of a clause in the 
policy known as the " memorandum." In this clause, 
the various articles which were then more particularly 
subjects of insurance were divided into classes, each of 
which was subject to special limitation. The first class 
was composed of articles peculiarly susceptible to dam- 
age, viz.: corn, fish, salt, fruit, flour, and seed. With 
respect to these articles, claim for damage or partial dam- 
age was excluded, unless the vessel stranded. The second 
class consisted of articles less liable to damage, such as 
sugar, tobacco, hemp, flax, hides, and skins. As to these 
goods, liability for damage was excluded unless amount- 
ing to 5 per cent. The third class included all other goods 
as well as the vessel and freight. These were insured 
excluding liability under 3 per cent, unless the vessel 
stranded. A similar clause was introduced in their pol- 
icies by American insurers in 1840, but the articles ex- 
cluded as to damage were considerably increased. At 
that time the importations into the United States were 
made up of articles, some of which were regarded as pecul- 
iarly susceptible of damage. More recently these condi- 
tions have been materially modified, and changes have 
been made to conform to the requirements of commerce, 
and extra premiums to cover the increased liability have 
been charged. 

In the early practice of marine insurance, the applicant 
prepared the policy on a form furnished to him and sub- 
mitted it to the insurer and, if accepted by the latter, he 
signed it, and thus he became what is now known as "the 
underwriter." The contract is signed by the underwriter 



MARINE INSURANCE POLICY 43 

only, but the assured also assumes certain obligations. 
It is quite manifest that good faith is an essential element 
in negotiating all contracts, but peculiarly so in one involv- 
ing such exceptional obligations and so complex in its 
character as a contract of marine insurance. Everything 
material to the risk must of necessity be frankly imparted 
to the underwriter and he, in turn, should carefully con- 
sider the interest of the assured when he accepts the risk. 
In the matter of valuation, the assured is entitled to insure 
his full interest in the venture, but he is not warranted 
in placing an excessive value on the property. If, how- 
ever, the underwriter agrees upon a specified valuation, 
it is binding unless there be fraud. Misrepresentation 
or withholding anything vital to the risk vitiates the 
insurance. 

An insurance may be made by the party in interest or 
through an agent. The practice is to submit particulars 
of the venture on which insurance is desired to the under- 
writer. A formal application is then prepared, outlining 
the details. This preliminary paper is signed by the 
applicant, and if the risk is accepted by the underwriter, 
he also signs it, and thus the contract is binding and the 
policy is subsequently issued, but, as before intimated, 
the policy is signed by the underwriter only. 

There are also implied warrantees, three in number, 
binding on the assured, although not incorporated in the 
policy. The first is that the ship or vessel is seaworthy; 
second, that she is to proceed without unnecessary delay 
from the port of departure direct to the port of destina- 
tion; third, that she is not to engage in any illicit trade 
and conforms to all the requirements of law as respects 
her credentials. 

As to the first of these, that is, the warranty of seaworthi- 
ness, the owner is under obligation to prepare her in all 
respects for the contemplated voyage, that is, on sailing, 
she must be tight and stanch in her hull, properly rigged 
(if a steamer, her machinery must be in good work- 



44 YALE READINGS IN INSURANCE 

ing condition); she must have an ample supply of 
fuel, she must be stored with provisions and provided 
with competent master and crew, with all things neces- 
sary for the intended voyage. Her cargo also must be 
properly stowed and not in excess in weight over what 
she can prudently carry. In fine, everything pertaining 
to the ship, her equipment, and cargo, must be on the line 
to insure safety, thus recognizing the obligation the ship 
owner has to the public, either as shipper of cargo or as 
passenger. 

A careful consideration of these implied warrantees 
as required by the common law will suggest to us both the 
wisdom and justice of them. It is proper to observe that 
the original form of bills of lading used in the shipment of 
cargo gave no immunity to the ship-owner for loss or dam- 
age to the property shipped, except in respect of losses 
caused by perils beyond the control of man to prevent 
or overcome, but in recent years attempts (as expressed 
by 1 a United States judge) have been made to limit as 
far as possible the liability of the vessel and her owners 
by inserting in bills of lading stipulations against losses 
arising from her unseaworthiness, and stowage and negli- 
gence in navigation, and other forms of liability which 
have been held by the courts of England, if not of this 
country, to be valid as contracts and to be respected even 
when they exempted the ship from the consequences of 
her own negligence. 

As decisions were made by the courts from time to 
time, holding the vessel for non-excepted liabilities, new 
clauses were inserted in the bills of lading to meet these 
decisions, until the common law responsibility of carriers 
by sea had been frittered away to such an extent that 
several of the leading commercial associations, both in 
this country and in England, had taken the subject in 
hand and suggested amendments to the maritime law 

1 Justice Brown of U. S. Supreme Court in case of " The Delaware," 
161, XL S., 471. 



MARINE INSURANCE POLICY 45 

in line with those embodied in the Harter Act. The act 
referred to bears the name of its author and was passed 
by the Congress of the United States in February, 1893. 
It renders null, void, and of no effect any clause, covenant, 
or agreement, whereby the ship-owner shall be relieved from 
liability for loss or damage arising from negligence, fault, 
or failure in proper loading, stowage, custody, care, or 
proper delivery of any and all lawful merchandise or prop- 
erty committed to his charge. 

The same act provides, that if the owner of any vessel 
transporting merchandise to or from any port in the United 
States shall exercise due diligence to make the vessel in 
all respects seaworthy and properly manned, equipped, 
and supplied, that he shall not become or be held respon- 
sible for damage or loss resulting from faults or errors in 
navigation or in the management of said vessel. 

It will be observed that the common law requirement as 
to seaworthiness, in other respects, is not abridged nor 
affected by the act, but much greater latitude is given in 
Great Britain to what is termed " special contract " in 
bills of lading. While this immunity from obligation 
certainly protects the ship-owner, it can hardly be said to 
be in the interests of the public. 

As to the second warranty, namely, making a direct 
passage, since the introduction of steam the modern form 
of bill of lading which is alleged to be a special contract 
gives liberty to deviate to any extent, so that with respect 
to steamers, at least, that warranty is largely modified. 

As to the premiums charged for the various risks, the 
rate in each case is dependent upon, 

1. The character of the vessel; this is deemed an 
important factor. 

2. The nature of the cargo. 

3. The dangers peculiar to the ports of loading and 
destination. 

Any underwriter is supposed to be familiar with the 
physical conditions of the different commercial ports of 



46 YALE READINGS IN INSURANCE 

the world, as well as the nature of their products, the 
means employed in loading and unloading the vessel, the 
direction to be taken by the vessel in her voyage and 
the time consumed in making it. These are the elemen- 
tary features of his qualifications. To say that he should 
also possess a discriminating mind and the power of dis- 
cerning occult conditions would be but the corollary of 
his required attainments. 

The word "average" frequently occurring in connection 
with marine insurance may be here explained. It is 
difficult to trace the origin of the meaning as now applied, 
but the use of it in maritime affairs, particularly in insur- 
ance, doubtless suggests a contribution in a sea venture. 
Particular average in marine insurance is damage to or 
partial loss of particular goods insured for which a contri- 
bution may be due from the underwriter. As, for example, 
A insured ten cases of dry goods. On arrival at destina- 
tion, one or all the cases are found to be damaged by perils 
of the sea; that would be "particular average"; or, if any 
number of the cases short of the whole were totally lost, 
that would also be particular average, but, in the latter 
case, under certain conditions, it might be considered a 
"constructive total loss." This will be hereafter explained. 

"General average" is a contribution due from all inter- 
ests in the venture, and if insured, recoverable from the 
insurer. General average occurs under the following 
circumstances: If during the voyage sacrifice be made of 
any part of the ship or cargo, or any extraordinary ex- 
pense incurred to prevent loss of the whole or to rescue the 
whole adventure from unusual peril, of if the ship be on 
fire and water is poured into the hold to extinguish the 
fire, the cargo damaged by the water would be general 
average, but the cargo damaged by fire only would be 
particular average, because the damage from that cause 
was accidental. 

Likewise, if the ship should be thrown on her beam 
ends by shifting of her cargo, or from any other cause, and 



MARINE INSURANCE POLICY 47. 

her spars are cut away to right her, or the hatches are 
opened and part of her cargo is jettisoned, i.e., thrown 
overboard to relieve her, the sacrifice so made, including 
the attending loss or damage in making it, would be con- 
tributed for in general average. 

The form of sacrifice termed " jettison" is more fre- 
quently resorted to than any other, and is perhaps the 
one that can more readily be made. When the hatches 
are opened for that purpose, if any of the cargo is damaged 
by water getting in to the hold, such damage is also contrib- 
uted for in general average. There is particular interest 
attached to sacrifice by jettison, as it is one of the earliest 
recorded in maritime ventures and was at first probably 
the only one recognized in the system of general average. 

The principle of sacrifice enjoins that when made it 
shall be the most weighty and of the least valuable of the 
cargo, but in an emergency requiring such prompt action 
the proper selection cannot always be made. If the goods 
sacrificed are insured, the assured can recover from his 
underwriter, assigning to him his right for contribution in 
general average. The underwriter also is liable for the 
general average contribution on property insured by him 
according to the sum insured, unless specially excluded 
in the policy. Cargo laden on deck, if jettisoned, is not, 
as a rule, contributed for in general average. 

General average, as before mentioned, is a part of 
maritime law, and all commercial nations have endeavored 
to bring its practice within the highest rules of equity, 
adapting it to various principles as they are unfolded 
from time to time. Several international congresses 
have been held for the consideration of the subject, no- 
tably, those at York, England, in 1864; and at Antwerp 
in 1877. At the latter congress a new code was adopted 
and designated York- Antwerp Rules. This code is fre- 
quently referred to as a basis of agreement in general 
average questions. But the practice as respects minor 
details varies somewhat in different countries. 



48 YALE READINGS IN INSURANCE 

Salvage is also a charge upon the property saved. The 
word salvage has a dual meaning. The dictionaries give 
the definition as "the compensation allowed to persons 
by whose voluntary exertions the vessel or cargo or the 
lives belonging to her are saved from danger or loss in 
case of wreck, capture, or other marine misad venture"; 
and also that "which is saved from the wrecked or aban- 
doned vessel." It will be noticed that both the com- 
pensation for saving and that which is saved is termed 
salvage. 

As an illustration of the operations of salvage, various 
cases might be cited, but one quite illustrious, and which 
has, to some extent, been made the subject of romance, 
may be mentioned. 

The brig "Mary Celeste" sailed from New York on 
November 7, 1872, destined for Genoa, Italy, with a cargo 
consisting of 1700 barrels of alcohol. The captain was 
accompanied by his wife, and his child, and the vessel 
had a crew of seven persons. There were two passengers 
on the vessel. On the 27th of November, in latitude 38 
north and longtitude 17 west, the brig was sighted by the 
brig " Dei Gratia," and when boarded by a part of the crew 
of that vessel, no one was found on the "Mary Celeste," 
although under full head of sail she appeared to have been 
sailing that way for three days. The last entry in the 
log book was made on the 24th of November. Her fore 
hatch was off, and, with the exception of the boats being 
missing, everything denoted perfect order. The indica- 
tions were that the people which were on her had left 
suddenly in the boats. She was towed into Gibraltar, 
the nearest port, and there the Admiralty Court awarded 
a salvage of £1700 — the equivalent of about $8300. 
This was a moderate compensation, being only about 
18 per cent, on an aggregate value of $47,000 for vessel, 
freight, and cargo. It is not unusual when derelicts, i.e., 
abandoned vessels, are picked up at sea, for a salvage 
award of more than twice that percentage to be made to 



MARINE INSURANCE POLICY 49 

the salvors. No tidings have ever been received of the 
people who sailed in this vessel, although the government 
used every means in its power to ascertain what had 
become of them. 

Savings of property from shipwreck are also termed 
salvage. 

We will now revert to the policy. The conditions in 
it are frequently changed by written clauses conforming 
to what is specially agreed upon between the assured and 
the underwriter. In order to reduce the cost of insurance, 
or for other reasons, the merchant may request the insur- 
ance made "free of particular average," which means that 
the underwriter will be relieved from liability for damage 
or partial damage to the goods. An insurance so made 
covers total loss and general average contribution. Gen- 
eral average is payable by the owner even though the 
goods be not insured. If insured the underwriter is liable 
for it, because the sacrifice or expense was incurred 
to save the venture from a total loss. The condition, 
"free of particular average," is now qualified in most insur- 
ances by adding " unless the vessel be stranded, sunk, 
burned, or in collision.' ' It is a form of clause intro- 
duced in the English policies. Some American insurers 
use the words, — " unless caused by the perils enumer- 
ated," that is, stranding, etc., thus eliminating the uncer- 
tainty as to the cause of damage. 

The difference between the two forms may be explained 
as follows: If cargo be insured under the English clause, 
free of particular average unless the vessel be stranded, 
etc., and while the vessel is proceeding out of her port of 
loading, touches bottom and remains ashore, even for a 
brief period, without sustaining any injury, it would be 
deemed a case of stranding, and although the cargo might 
not be damaged or injured in any form by such stranding, 
yet the fact of that innocuous stranding would cause a 
change in the policy, and the cargo insured would then be 
subject to, instead of free of, particular average, and for 



50 YALE READINGS IN INSURANCE 

any damage sustained by heavy weather on the passage, 
the underwriter would be liable. 

Any writing in the policy takes precedence of the 
printed part to which it is opposed, and sometimes printed 
clauses in red are introduced in the policy to nullify certain 
printed conditions in the body of the policy. For example, 
the risk of capture and other warlike measures, are named 
as perils insured against, but a side clause, when inserted 
in the policy, exonerates the insurer from liability from 
such losses, risks of war and all losses incidental to war, and 
when by reason of the actual existence of war the mer- 
chant deems it necessary to have that risk covered, when 
agreed upon with the underwriter the exonerating clause 
is waived, thus restoring the policy to its normal condi- 
tion and covering the war risks. When that risk is as- 
sumed by the underwriter, a large premium is added to 
the ordinary marine premium. The risk of war is deemed 
greater than all the other perils enumerated in the policy, 
thus showing that the winds and waves and the raging of 
the sea do not equal the destructive tendencies of man 
when his frenzy is aroused. During our Civil War one 
insurance company paid nearly $2,000,000 in losses for 
war risks, and the Confederate cruisers destroyed by burn- 
ing at sea 18 ships, 7 barks, 4 schooners, 1 brig, and 1 
steamer — 31 vessels in all, and about the closing of the 
war one of the same cruisers proceeded to the Arctic 
Ocean and destroyed 15 whalers. It is estimated that 
the amount of property destroyed on the high seas by 
Confederate cruisers aggregated over $20,000,000. 

The printed form of policy insuring vessel, freight, 
cargo, or profits is essentially the same. It differs only 
as it is adapted to apply to the character of the respective 
interests insured. There is, however, a special name given 
to each policy, corresponding with the risk it is designed 
to cover. For example, the policy insuring a risk for a 
single voyage, as from New York to Liverpool, is called a 
voyage policy. 



MARINE INSURANCE POLICY 51 

A time policy insures a vessel for a specified time, usu- 
ally for one year. In Great Britain, no insurance can be 
legally made for a longer period than one year at a time. 
No such legal enactment prevails in the United States. 

A valued policy is one giving a definite value to the 
property insured. An open policy is one where the value 
is left open to be determined when ascertained upon receiv- 
ing the shipping documents. A floating policy covers by 
vessel or vessels, either sailing or steam, and insures the 
goods as soon as shipped. Details of each shipment, when 
received by the consignee, are reported to the insurer and 
premium is charged thereon. This latter class of policy 
is rendered necessary in the business of importers, who 
frequently order their goods several months in advance of 
the time of shipment, and they are not usually advised 
of the shipments until the goods arrive. 

A wager policy is one that shows on the face of it that 
the assured has no interest in the property. This class of 
insurance, that is, one without interest, has been quite 
common in England, but during the reign of George III., 
under statute 19, insurance without interest was declared 
illegal, but such insurances are still made on the basis of 
what is termed honor transactions. In the United States 
it would be difficult, indeed, to recover in any of the 
courts under a policy where the principals had no interest 
in the property insured. It is to be observed that an 
interest in the property is an indispensable condition of 
all modern insurance. 

As touching the duration of the various classes of risks, 
the policy reads: " Beginning the adventure upon said 
goods and merchandises from and immediately following 
the loading thereof on board of the said vessel/' The 
goods thus insured are covered from the time that they 
are loaded on the vessel, but, in some cases, the ships are 
not lying at the wharf, and therefore the goods so insured 
are transported in lighters to the vessel. In such cases 
the risk of lighterage is included. As to the termination, 



52 YALE READINGS IN INSURANCE 

it says: "And so shall continue and endure until the said 
goods and merchandises shall be safely landed at the 
destination," so 'that, if the goods are lightered from the 
vessel to the shore, that part of the risk would also be 
covered. The risk of lighterage is by no means an imma- 
terial one. Losses on lighters are not infrequent. 

The great advance made in the construction of ships as 
well as the improved condition in navigating them has 
materially minimized maritime risks, but one dreaded 
cause of disasters on the ocean is that of collision. The 
construction of large steamships, commonly known as 
" greyhounds, " has added immensely to the attractions 
and speed of modern travel. We can hardly realize the 
progress made in naval architecture nor can the advance 
in the science of navigation be fully estimated. Not 
unlike everything else in modern life, we have obtained 
these at the cost of increased danger. The experienced 
navigator may be serene in a terrific storm, when the 
violence of the wind and the waves may appall the 
affrighted landsman, for the sailor knows his ship and has 
faith in her power to overcome all. When, however, he 
is beset by fog, there is no escape but to pass through it, 
and in doing so he knows not what he will encounter. His 
experience and skill are of no avail in this emergency. He 
may carefully observe all the rules and requirements of mari- 
time law, as well as those enjoined by experience, but the 
mistakes and omissions of others he cannot foresee. He 
is plunging in the dark, and how frequently it has happened 
that, when thus enveloped in apparent darkness, dire 
disaster has been the consequence, through the faults of 
others, when he himself has made all the sacrifices within 
human power to prevent the possibility of such a fatal 
result. Collisions at sea are therefore regarded as one 
of the great perils of modern navigation. It was not until 
within the past half century that the question assumed a 
legal form as to the liability of a ship-owner for damage 
inflicted on other ships or vessels through collision. Rules 



MARINE INSURANCE POLICY 53 

of the road have been clearly defined and the requirements 
in cases of fog have been very carefully outlined, but it 
can readily be seen that the consequences of disaster to a 
valuable ship would result in immense loss to the ship- 
owner, whose vessel had sunk another. Therefore legis- 
lation has come to his assistance, and in Great Britain the 
following statutory law has been enacted: 

"Where any loss or damage is caused to any other vessel, 
or to any goods, merchandise, or other thing whatsoever 
on board any other vessel, by reason of the improper 
navigation of a ship in respect of loss or of damage to 
vessel, goods, merchandise, or other things, whether 
there be in addition loss of life or personal injury or not, 
an aggregate amount not exceeding £8 — for each ton of 
their ship's tonnage, £7 — addition for loss of life or 
personal injury. The tonnage of a ship shall be her 
gross tonnage, without deduction on account of engine- 
room, and the tonnage of a sailing vessel shall be her 
registered tonnage." (Merchants' Shipping Act, 1894.) 

The law of the United States on the same subject reads 
as follows: 

"The liability of the owner of any vessel for any em- 
bezzlement, loss, or destruction by any person of any 
property, goods, or merchandise shipped or put aboard 
of such vessel, or for any loss, damage or injury by colli- 
sion, or for any act, matter or thing, loss, damage or for- 
feiture done, occasioned or incurred without the privy or 
knowledge of such owner or owners, shall in no case exceed 
the amount or value of the interest of such owner in such 
vessel, and her freight, then pending." (Revised Statute 
4283, Bureau of Navigations, 1903.) 

It will be noticed that in the English law the liability is 
defined according to the size of the vessel, that is, her 
tonnage, while in the United States it is her entire value, 
which is to be determined when the legal proceedings have 
resulted as to the liability of the owner for the loss. The 
ordinary form of policy does not cover liability of the owner 



54 YALE READINGS IN INSURANCE 

for damage inflicted to other vessels by collision, through 
the fault of his vessel. In order to protect himself, special 
insurance is made, which in some cases has been coupled 
with the policy insuring the vessel against ordinary risks. 
In most cases such insurance covers only three-fourths of 
the owner's liability for loss, leaving him to assume one- 
fourth of it, so that he will exercise diligence and care in 
the selection of competent and suitable navigators for 
his vessel. 

It will be noticed that the foregoing relates to the dam- 
age inflicted on the other vessel. The damage received 
by the insured vessel comes under the liability of the under- 
writer on that vessel. When it is legally determined 
which of the colliding vessels is at fault, the liability for 
loss will fall upon the one found to be at fault. By the 
rules of law administered at the Court of Admiralty, when 
both vessels are to blame, even though not in equal degrees, 
the whole loss sustained by their owners is apportioned 
equally between the two. Each party becomes liable to 
pay to the other one-half of the damage which he has 
sustained. 1 

Next to collision and probably the greatest menace to 
ocean navigation is fire. This peril is so subtle and diffi- 
cult to overcome that it assumes an appalling character. 
It is not only the direct cause of heavy marine losses, but 
is frequently attended with serious loss of human life. 
In recent years means have been employed through skil- 
ful inventions to locate fire in the hold of a vessel and to 
smother it, but these means have not always proved effec- 
tive. 

An insurance made free of general and particular average 
reduces the liability under the policy to total loss only, 
but there are various conditions in which the property 
may not be absolutely lost and yet be regarded a total 
loss under the policy. There might be what is technically 
termed "constructive total loss." An actual total loss 

1 Carver on "Carriage by Sea." 



MARINE INSURANCE POLICY 55 

is when the property insured is actually lost or destroyed 
by the perils insured against. Constructive total loss 
may arise when, by any of the perils named in the policy, 
the voyage cannot be performed or the property is so 
damaged as to be of little value, or the expense to forward 
it to destination would be equal to or exceed the value 
of the property, necessitating its sale at an intermediate 
port. In such a case the assured can claim a total loss 
under his policy. The same principle applies to insur- 
ances on the hulls of vessels. If an insured vessel is 
seriously damaged through perils insured against and the 
cost of repairing her exceeds her value, the assured may 
abandon her to the underwriter and claim as for a total 
loss under his policy. 

Insurance on a vessel for a voyage only commences 
after it is made, the vessel being then in port, either load- 
ing or ready to load, and terminates twenty-four hours 
after her arrival at the port of destination and being moored 
therein in good safety. Insurance on freight (this interest 
represents the earnings of the vessel for carrying the cargo) 
begins at the port of loading and runs simultaneously 
with the insurance on the cargo so laden, that is, until 
actually discharged from the vessel. 

Charter is an agreement to hire the vessel, either to 
load at the port where she is, or to proceed to another port 
to take in a cargo for the ultimate destination. Insurance 
on such an interest covers from the time the same is made 
binding, even though the vessel has to proceed to another 
port to load the cargo, and terminates upon the discharge 
of the cargo. 

Reference has been made to profits as an insurable 
interest. This may occur under the following conditions: 
If a merchant should purchase certain articles of mer- 
chandise which have not arrived at destination, and there 
be an advance in the market so that he has a profit in the 
goods, he has an insurable interest in such profit, and 
may insure it, even though the property itself was originally 



56 YALE READINGS IN INSURANCE 

insured by the seller. An insurance thus made would 
represent an insurable interest, even though a subsequent 
change in the market might have resulted in there being 
no profit in the goods on their arrival. 

We will now refer to the methods of settlement of losses. 
As respects total losses, the method is simple. It requires 
the ordinary proof, such, for example, as the protest of 
the master. Immediately after the loss of the ship, it is 
the duty of the master to repair to the office of the United 
States consul, if at a foreign port, and if in a port of the 
United States to a notary public, and he, together with a 
part of his crew, sets forth the circumstances under which 
the vessel was lost, and protests against the perils which 
resulted in the loss. This document is called a protest. 
The circumstances, as recorded in the log book of the ship, 
are noted in the protest under oath or affirmation, and the 
consul then furnishes the master with an authenticated 
copy. This is termed " proof of loss." If the insurance 
be on the ship, the proof of interest would consist of the 
register of the vessel recorded in the custom house, nam- 
ing the owner and the extent of his interest in the ship. 
If the insurance be on the freight, a manifest of the vessel, 
setting forth the cargo laden and the freight thereon, or, 
if a charter, the charter party, giving the interest. As 
respects insurance on cargo, to distant ports, underwriters 
have, as a rule, representatives at most of the maritime 
ports of the world whose agency is called into requisition 
in case of damage to cargo. The agent agrees on a com- 
promise, or, if that cannot be reached, a sale at auction 
may be resorted to. The agent then gives the consignee 
an appraisement, detailing the nature of the settlement, 
with a certificate of the market value of the goods. If the 
sale at auction be made, the sum realized on the goods, 
deducted from the market value, represents the loss sus- 
tained by the merchant. The percentage of loss thus 
determined is applied to the sum insured. An example 
of such an adjustment is herewith presented : 



MARINE INSURANCE POLICY 57 

100 bbls. flour, insured for and valued at $5.00 per barrel . . . $500.00 

Flour being insured subject to 5 per cent, particular 

average, necessary for a claim, $25.00 
Sound value at port of destination, $7.00 per barrel . . $700.00 
Being damaged, sold for, say, $3.50 per barrel 350.00 

Deterioration, 50 per cent $350.00 

Insured value, $500.00, at 50 per cent, loss $250.00 

Add extra charges: 

Auctioneer's commission, 2\ per cent $8.75 

Surveyor's fee 5.00 

Advertising 1.25 15.00 

Loss $265.00 

It will thus be noticed that the underwriter pays the 
percentage of loss ascertained as above, applied to the 
amount on which he has received premium, and, while 
the percentage is ascertained on a higher basis than the 
sum insured, yet it must be borne in mind that freight 
has been paid on the flour from the port of importation, 
likewise duties, and other incidental expenses, in placing 
the goods where a higher market of necessity prevailed. 

As respects particular average on the hulls of vessels: 
Should an insurance be made of $10,000 on a wooden ship 
valued at $50,000, the vessel being what is termed, "sub- 
ject to 5 per cent, particular average," which means that 
the underwriter will be liable for loss if amounting to 5 
per cent, on the entire value of the vessel, that percentage 
is ascertained after deducting one-third new for old; that 
is, the repairs being made upon the vessel, the under- 
writer pays only two-thirds of the cost, and the adjustment 
would be as follows : 



58 YALE READINGS IN INSURANCE 

$10,000 insured, valued at $50,000; required, necessary for a claim, 
$2,500. 

Repairs Particular Net 

Average 

To Hull $3,000.00 

Rigging and sails 800.00 

Masts and spars 1,200.00 

$5,000.00 
Cr. for old materials 500.00 

$4,500.00 
Off, $ new for old 1,500.00 

$3,000.00 
Protest and surveys 50.00 

Particular average $3,050.00 

Policy for $10,000 as above will pay, $610. 

Ships are now mostly built of iron or steel, and when 
repairs are made upon vessels so constructed no deduction 
of one-third new for old is made unless the vessel be very 
old. 

In most of the American policies provision is made 
for the payment of loss thirty days after presentation 
of proofs of loss. Time is thus given to the under- 
writers to have an opportunity to examine the papers 
and make the necessary adjustment of the loss, but, as a 
rule, these payments are made much sooner than the time 
indicated. Cases are not infrequent where an assured 
presents his papers, and, the loss being a simple one, as 
stated in case of a total loss, in the course of two or three 
hours the adjustment is made and the loss paid that day. 



CHAPTER III 

HISTORY OF FIRE INSURANCE IN EUROPE * 

Fire insurance as now commonly practised is usually 
considered to have begun after the great conflagration of 
London in 1666. While marine insurance — the oldest 
form of insurance in existence — had been steadily develop- 
ing and extending with the great expansion of trade and 
navigation which followed the discovery of the New World, 
and although merchants and ship owners from very 
remote times clearly foresaw and provided against the 
perils of navigation, very little specific attempt was made 
by property owners to secure indemnity for loss caused 
by fire prior to the date above mentioned. 

It is true that some forms of provision for the aid of 
those suffering from loss by fire and other calamitous 
causes apparently existed in very remote times, as the 
following quotation will evidence : 

"The earliest application of fire insurance known to us 
was in connection with communes of towns and districts. 
These communes flourished in Assyria and the East more 
than 2500 years ago. Judges, priests, and magistrates 
were appoineed for each town and district with power to 
levy contributions from each member of the commune to 
provide a fund against sudden calamities such as drought 
and fire. If the judges were satisfied that the fire was 

1 By Richard M. Bissell. Lecture at Yale University, January 11, 
1904. Reprinted from pages 13-24 of the "Yale Lectures on Insur- 
ance, Fire and Miscellaneous," 1904. 

59 



60 YALE READINGS IN INSURANCE 

accidental they empowered the magistrates to assess the 
members of the commune either in kind or in money, and 
in the event of any member being unable through poverty 
to meet his share of the contribution, the deficiency was 
made up from the common fund. These communes still 
exist in a modified form in China." 

As early as 1240 a.d. the laws of Count Thomas of 
Flanders provided that the members of a community as 
a whole should make good a loss which fire might cause 
to an individual, unless the incendiary who caused the fire 
could be discovered, in which case the loss was to be made 
good from his property and he was to be banished. 

It will be noted that the plans outlined above contem- 
plated an assessment by the state and that all property 
owners were protected. We may discover here, therefore, 
the beginning of state fire insurance, which will be later 
more fully described and which continues in Germany and 
elsewhere to this day on a large scale. 

Another method for protection and security against 
loss by fire, water, robbery, or other calamities, arose 
during the Middle Ages in connection with the various 
Anglo-Saxon and German guilds, the members of which 
made regular contributions toward a common relief fund. 

In 1609 a plan was suggested by one of his subjects to 
Count Von Oldenberg, wherein it was proposed that he 
individually should consent to insure those of his sub- 
jects, who might so desire, against the loss of their houses 
by fire upon an annual payment to him of a fee or premium 
of one dollar for every one hundred dollars of valuation. 
This suggestion was declined by the Count, though not 
without some hesitation, and, though he suggested that 
such a plan might well be undertaken by a company of 
private individuals, no action on his suggestion seems to 
have been taken. This, so far as I have been able to 
discover, was the first suggestion ever made looking 
toward the formation of a company or association for fire 
insurance purposes only. 



FIRE INSURANCE IN EUROPE 61 

In England various fire insurance schemes were pro- 
posed in 1635, 1638, and 1660, but for one reason or another 
— largely owing to the great Civil War — none of them 
was fully organized, and as late as 1667 there is evidence 
that fire insurance as we know it did not exist. 

In 1666 came the great fire of London, which burned 
for four days and nights and spread over 436 acres of 
territory. This was an alarming and appalling calamity. 
Over 85 per cent, of the buildings in London were destroyed, 
while the property loss is estimated to have been about 
ten million pounds, — a sum which has been calculated 
to equal over three hundred million dollars at present 
values. In the absence of insurance this was a blow from 
which London was slow to recover, as is shown by the fact 
that in 1673, seven years later, about one thousand build- 
ings were yet to be replaced. Relatively, this London fire 
was the greatest in the history of the world, and the date 
of it — September 2 — was observed as a Fast Day for 
more than one hundred years thereafter. 

Immediately after the fire various plans for the pro- 
tection of individuals against loss by fire began to be 
devised. In 1667 the first regular system for insuring 
buildings against fire began. In that year, one Nicholas 
Barbon opened an office where he individually proposed 
to insure houses and buildings. A few years later, in 1680, 
after having had some success, he formed a partnership 
known as "The Fire Office." This company, for a given 
consideration, engaged to pay the assured the amount of 
indemnity declared in the policy, or contract, should his 
house or building be destroyed by fire, or to repair it should 
it be only " damnified" — i.e., damaged. No liability, it 
will be noted, rested upon the assured beyond the payment 
of the premium. 

In 1681, a few years after this first company was estab- 
lished, an attempt was made by the city of London to 
establish an insurance account, or business, and funds and 
property were put aside and dedicated for that purpose. 



62 YALE READINGS IN INSURANCE 

Houses were insured for any term up to one hundred years. 
But the enterprise did not prosper and was abandoned in 
1683. 

Then followed, in the same year, what was called the 
"Friendly Society." This concern, which had an exist- 
ence of nearly one hundred years, conducted its business 
upon an entirely different plan, as follows: First, the 
assured paid yearly a small sum, varying according as the 
building to be insured was brick or frame. This charge 
was to cover the expenses and, we may presume, the profits 
of those who operated the company. Second, the assured 
deposited with the company a sum equal to five annual 
payments as a guarantee that future payments and assess- 
ments would be met as required. This money could be 
appropriated by the company if the assured failed to keep 
up his payments. Third, the assured signed an agreement 
to contribute his share toward the payment of any and 
every loss which the company might sustain up to an 
amount not exceeding thirty shillings for every one hun- 
dred pounds of insurance carried by him. It will be seen 
that all losses were to be paid from the contribution of the 
assured, upon whom, also, rested all liability and for whom 
the operators of the company or the " undertakers," as 
they were termed, acted only as collectors and distributors. 

This was a form of mutual insurance, as it is now called ; 
that is to say, insurance where the policy-holders are 
directly liable for one another's losses. This company 
was also fairly successful. 

Another purely mutual company was organized in 1696. 
This company proposed a deposit to be paid back, less 
expenses, when contracts should terminate; also that 
profits from interest on invested funds over and above 
losses and expenses should be divided among the members 
or policy-holders, and that each year a rate of assessment 
should be declared by the directors, according to which 
levies should be made on the policy-holders for payment 
of losses or for the distribution of profits to them. It 



FIRE INSURANCE IN EUROPE 63 

was assumed that the interest or earnings from the accu- 
mulated deposits would pay all losses, and this seems to 
have been the case, for the company prospered and grew 
and is in existence to-day, having greatly developed in 
size and scope, being the oldest insurance company in 
existence. Its operations are limited to London and its 
suburbs. The original title of this company was " Con- 
tributors for Insuring Houses, Chambers or Rooms from 
Loss by Fire by Amicable Contribution." This was after- 
ward changed to " Amicable Contributionship," and in 
1776 the name of "Hand in Hand" — taken from an em- 
blem used by the company in marking and designating 
buildings which it insured — was adopted. 

The companies heretofore mentioned all confined their 
operations to buildings and mostly to dwellings only, but 
the need for insurance upon goods and stocks of merchan- 
dise was very great. About 1706, one Charles Povey 
opened an office for insuring such property in London. 
He was without backing or support of any kind and fur- 
nished merely his promise to pay in event of loss. This 
venture was apparently greeted with ridicule and the pro- 
posal to insure personal property seems to have been 
commonly considered impractical. Nevertheless Povey per- 
sisted and soon began another enterprise designed to insure 
personal property throughout Great Britain and Ireland, 
but finding his first venture unprofitable devised the scheme 
(which would seem to be quite in accord with some very 
modern methods of corporate finance), of organizing a 
third institution to take over the other two. This was 
accomplished. The new concern was at first called the 
" London Insurers/' but almost immediately after its 
formal inaugury in 1710 it adopted the name of the Sun 
Fire Office, and under this name began its successful career 
which still endures, making that office the oldest non- 
mutual company in existence as well as the first company 
which ever undertook the insurance of movables or per- 
sonal property. It has continued to be a partnership, i.e., 



64 YALE READINGS IN INSURANCE 

not a corporation, and is almost unique among insurance 
companies in that respect. The first contracts of the Sun 
provided for payment of losses out of a reserve to be made 
up of one-half the premiums paid, the liability of the com- 
pany ceasing when that reserve should be exhausted. 
Later the company, doubtless under stress of competition, 
made its promise to pay absolute, and in 1726 a capital 
fund of 48,000 pounds was created as additional security 
for policy-holders. 

Another curious feature of the contracts made by this 
first company doing general business was the proviso that 
in case of loss, 5 per cent, should be deducted from claims 
for defraying the expenses of the company's officers in 
investigating and settling the loss. This was reduced to 
3 per cent, in 1716, and abandoned altogether not later 
than 1794. This feature seems to have been quite com- 
mon among insurance companies during the early history 
of the business, but was too obviously open to objection 
and criticism to endure after serious competition arose. 

Between 1710 and 1720 numerous insurance schemes 
were launched, modeled after one or the other of those 
described above. Some succeeded, more failed or were 
wound up. In 1720 the first chartered companies or cor- 
porations made their appearance. In that year two com- 
panies — the Royal Exchange Assurance Company and 
the London Assurance Corporation — were granted char- 
ters, first to do a marine insurance business, and in the 
following year to transact also fire and life insurance busi- 
ness. This date then, 1720, marks the advent of modern 
stock companies in fire insurance. One of the first 
announcements, or " broadsides" (as such notices were then 
styled) of the Royal Exchange Assurance contains the 
following as one of the arguments which should persuade 
insurers to patronize it rather than the mutual associations 
or contributionships theretofore doing most of the busi- 
ness: 

"For the security of all persons insured by this Cor- 



FIRE INSURANCE IN EUROPE 65 

poration, their capital stock or fund is by their charter 
established and made liable and shall always be ready 
to pay and make good to the assured the amount of all 
losses by fire." 

Later in the same paper appeared the following: 

"And whereas persons assured by other societies not 
incorporated, are subject to calls in case of a loss or a 
deduction out of the money due to the sufferer, those that 
are assured by this Corporation are not liable to any calls 
(i.e., assessments), or deductions whatsoever." 

These considerations — namely, freedom from all per- 
sonal liability on the part of the assured beyond payment 
of a fixed premium and the fact that in the case of stock 
companies their entire capital stock and accumulated 
funds are pledged to the payment of losses — have no 
doubt chiefly caused the commercial world to favor stock 
companies or corporations up to this date, when such com- 
panies do a very large proportion of all the fire insurance 
business. 

This may be said to bring the history of fire insurance 
in Great Britain down to modern times. During the last 
three-quarters of the eighteenth century fire insurance 
companies, both mutual and stock, but chiefly the latter, 
were organized in very considerable numbers and for the 
most part copied the methods, contracts, and practices 
of the earlier companies. Many of these companies still 
survive; indeed, some of the largest English companies 
in existence date from that period. 

The early histories of these first ventures in fire insurance 
contain much curious and interesting matter, but time 
and space do not permit a study of their plans and methods. 
One feature of their early operations, however, has de- 
veloped to such great proportions and has become of such 
great importance as to demand mention here, namely, the 
protection of property against fire. It was a natural and 
immediate outcome of the first attempt at fire insurance 
by Nicholas Barbon that his interest in fires and their pre- 



66 YALE READINGS IN INSURANCE 

vention should be greatly augumented. Accordingly his 
and the other early offices devised metal house plates to 
be securely fastened to those buildings which might be cov- 
ered by their policies, and then hired men and provided 
some simple apparatus for extinguishing the fires which 
might arise in or near the buildings so marked. These 
house plates were also considered as a mark of acceptance 
and assumption of liability by the companies. Some 
offices even stipulated that liability should not begin until 
their plate had been affixed to the building which the policy 
was to cover. This it was thought tended to hinder fraud 
and prevent disputes. Moreover, because they brought a 
building under the protection of the company's firemen 
and because they evidenced to the public the fact that the 
property owner would not be ruined by fire, these plates 
were esteemed as desirable and valuable by policy-holders. 
They became in fact a sort of basis of credit, and the 
custom of using these plates endured, especially in smaller 
places, long after their original use had disappeared. In 
fact, such plates are used in some foreign countries to- 
day. In America their use was very common until about 
twenty-five years ago; they may still be seen over the 
door of many New England homes and are not yet entirely 
obsolete among the farmers in some sections of the 
country. 

The ordinary method of preventing the spread of fire 
at that period seems to have been by blowing up buildings 
by gunpowder, and this work was commonly done by 
the artillery, or Royal Gunners. The early insurance 
companies used also bucket brigades and hand-pumping 
engines. Each company had its own liveried firemen, 
who were expected to guard its interests. Later some of 
the companies organized corps of watchmen and patrol- 
men who should discover fires in their incipiency, give 
the alarm and summon the firemen of the company for 
whom they worked. Still later, when the practice of 
insuring personal property began, it was found advisable 



FIRE INSURANCE IN EUROPE 67 

by the Sun office — the first, it will be remembered, to 
transact that class of business — to provide a body of 
men for the purpose of removing insured goods from burn- 
ing buildings and for protecting them when so removed 
from thieves and pilferers. As companies multiplied, so did 
their private fire and salvage corps increase in number, 
until in 1808 fifty fire engines were kept up by the com- 
panies in London alone. In 1825 a number of these com- 
panies consolidated their fire brigades. In 1833 all were 
united, but not till 1866 was the establishment turned 
over to the city. It seems very strange that private 
corporations should have so long been allowed to con- 
trol and direct this important branch of civic adminis- 
tration. 

Inasmuch as modern fire insurance had its genesis and 
early development in Great Britain, whence also American 
ideas and practices were derived, we have devoted most of 
our limited time to the early history of the business there 
and can give but ; slight and incidental attention to the 
subject in other foreign countries. This course has seemed 
to be proper, not only for the reason just mentioned, but 
because English fire insurance companies have developed 
more rapidly and, following the track of English ships 
and commerce, have carried their operations throughout 
the world to a far greater extent than the companies of 
any other country. There is no quarter of the globe 
where fire insurance may not be obtained from English 
offices. The insurance companies of other countries for 
the most part confine their operations to their own coun- 
try, with the exception perhaps of Germany, the com- 
panies of which country have in later years also embarked 
in the world-wide business. 

In the various kingdoms and provinces which now 
constitute the German Empire, as has been mentioned 
before, the various communal guilds had provided some 
crude form of insurance for their members, and in many 
places this function was transferred to the various munici- 



68 YALE READINGS IN INSURANCE 

palities as the guilds disappeared. One writer describes 
this process as follows: "As the absolute monarchical 
police-state constitutes the bridge between the middle 
ages and modern times, so too the transition from the 
mediaeval guild plan of mutual help to the modern system 
was bridged by state insurance. The guilds of the middle 
ages lost their importance and private industry was not 
rapid enough to supply the void left by them, and so the 
state was forced to step into the breach." l 

Such public fire insurance outside of Germany is still 
to be found in German-Austria, Denmark, Switzerland, 
and Scandinavia. At a comparatively recent date about 
40 per cent, of the outstanding insurance in Germany was 
carried by the institutions conducted by the government 
or by various municipalities. Throughout Germany and 
Switzerland to-day all buildings of ordinary occupancy 
are assured by the government as soon as built. Each 
owner is assessed pro rata, according to the appraised 
value of his own insured buildings, for the losses within 
the state. Money payments are not made by the state 
in event of loss, but the damage is repaired or the building 
replaced by the government. The necessity for insurance 
on other classes of property than buildings caused the 
formation of the first stock company in Germany in 1812, 
since which time many companies, both stock and mutual, 
have arisen, also various local associations similar to the 
old guilds and perhaps descendants from them. 

In France, while various insurance companies were set 
on foot during the second and third quarters of the eigh- 
teenth century, all perished during the general financial 
collapse which accompanied the French Revolution. The 
first regular stock company organized thereafter seems to 
date from 1818. 

In other European countries fire insurance seems to 
have had even a later development — thus in Austria the 
first stock company was organized in 1822, and the first 

1 J. S. Bloomingston, Ph.D., "Fire Insurance." 



FIRE INSURANCE IN EUROPE 69 

mutual company in 1825. In Russia the first company 
appeared in 1827. 

In all civilized countries there are now fire insurance 
companies, even in China. 

Methods and plans vary in different parts of Europe. 
In France, under the Code Napoleon, every individual is 
liable for loss or damage which may happen to others 
through his fault. In case of fire the law holds that the 
fault rests with the tenant or owner on whose premises the 
fire originates, unless he can prove himself without fault; 
in other words, the burden of proof is on him. Hence a 
tenant, for example, takes out insurance first on his own 
personal property; second, to protect him against possible 
claims to be made by his landlord, and third, to protect 
him against possible liability to his neighbors for damages 
resulting from fires attributable or attributed to his care- 
lessness or negligence. It would be highly instructive to 
compare more completely the varying conditions and 
methods under and by means of which the business of 
fire insurance is conducted in different parts of the world, 
but we cannot attempt it here. 



CHAPTER IV 

HISTORY OF FIRE INSURANCE IN THE UNITED STATES 1 

In a history of fire insurance in this country one must 
of necessity consider whence the business came, the stage 
of its development, when it came and, to some degree, 
its originating cause. Only enough can be said on these 
points to identify its origin, establish the line of descent, 
and set forth how and when it came to be brought to this 
country. Furthermore, the consideration of so large a 
subject in a brief paper can only be of a skeleton char- 
acter with a fair emphasis upon some of the formative 
factors. 

One of the results of the great fire of London in 1666 
was the devising of plans for the protection of individuals 
against loss by fire. The great fire of London was rela- 
tively the greatest in the history of the world, over three- 
fourths of the buildings in the city having been destroyed, 
and the estimated loss aggregating about ten million 
pounds sterling. So great indeed was this loss that, ten 
years later, the buildings had not all been replaced. Quite 
a number of plans were tried, and before the close of the 
century a company, which finally became the Hand-in- 
Hand, was established. In 1706 Charles Povey opened 
an office in London for insuring property owners in that 
city against loss from fire, but his plan merely involved 
his promise to pay. Shortly after this first attempt he 
started another enterprise for the purpose of insuring 

1 By F. C. Oviatt. Lecture at the University of Pennsylvania. 
Reprinted from pages 335-358, Volume XXVI of the Annals of the 
American Academy of Political and Social Science, September, 1905. 

70 



FIRE INSURANCE IN THE UNITED STATES 71 

against loss from the destruction by fire of personal prop- 
erty throughout Great Britain and Ireland, and in 1710 
organized a proprietary or stock company which took 
over these two institutions, and which was named the 
Sun Fire Office, though commonly referred to at present 
as the Sun, of London, which still exists as one of the 
leading fire insurance corporations of the world, and is as 
familiarly known in this country as at home. In 1720 
two more companies were chartered, which still exist, and 
both of which maintain branches in the United States, 
namely, the Royal Exchange and the London Assurance. 

Fire insurance may be said to be due to an idea born 
of necessity and only existing at the beginning of the 
eighteenth century in a crude and experimental form. 
The period being the colonizing one, the Englishmen who 
came as settlers to this country brought the idea with 
them, so that the development of the thought of making 
the fire loss less burdensome to the individual is as much, 
if not more, American than British. Originating in Eng- 
land, two separate lines of fire insurance development 
have been carried forward, each influenced by local features 
of indemnification, but with remarkable fidelity to type, 
and from these differing lines of development has grown 
up an international business factor of large importance. 

Having noted its origin and traced the line of descent, 
let us now follow the fortunes of the younger branch of 
the fire insurance family as developed in this country. In 
doing this it may be noted that fire insurance and the 
more employed marine insurance became early factors 
in the commercial development of the colonies. They 
grew with the growth of the business of the country, and 
have been part of the bone and sinew of material prosperity 
of the American people. 

The first forms of insurance in this country were marine. 
In 1682, as we are informed from records, vessels engaged 
in trade between England and the colonies were insured 
against the perils of the sea, and as early as 1721 an 



72 YALE READINGS IN INSURANCE 

advertisement appeared in the American Weekly Mercury 
announcing that John Copson, of High Street, Philadelphia, 
would open an office for insurance on "vessels, goods 
and merchandise." For a long period the insurance busi- 
ness of the colonies continued to be marine; part of it 
being written by agents of English companies, and the 
remainder being issued in American ports. In 1762, at 
the London Coffee House, at the southwest corner of High 
and Front Streets, Philadelphia, John Kidd and William 
Bradford announced that they would underwrite risks 
in general, and before the close of the century a consider- 
able number of such offices had been established. In 
Philadelphia the first steps toward the protection of 
property took the form of organizations for the extin- 
guishment of fires and regulations concerning the nature 
and location of buildings. In 1730 the city authorized 
the purchase of three more engines, four hundred buckets, 
twenty ladders, and twenty-five hooks, and in 1752 with 
approximately 2,076 dwelling houses (not including 
churches, public buildings, warehouses, and workshops), 
the city possessed seven fire extinguishing companies. 

In this same year the Pennsylvania Gazette, under date 
of February 18, contained an advertisement of proposed 
articles of insurance of houses from fire in or near the city. 
The plan had the approval of the lieutenant-governor 
of the province and of Benjamin Franklin, and on April 13 
directors were elected, and the Philadelphia Contribution- 
ship was thus formally organized, being the first fire insur- 
ance company to be organized in the United States. Its 
plans were an adaptation of those of the Hand-in-Hand 
of London; in fact, the company became quite generally 
known as the Hand-in-Hand, and its first house mark was 
four hands clasping wrists. One curious incident should 
be noted. The directors of the Contributionship in 1781 
decided that houses having trees planted before them 
should not be insured, because the trees made it difficult to 
fight fires. This policy created considerable friction and 



FIRE INSURANCE IN THE UNITED STATES 73 

opposition, out of which grew, in 1784, the Mutual Assur- 
ance Company. The house mark of this new company 
was a green tree, cast in lead, fastened to a shield-shaped 
board, affixed to the front of the insured property. Both 
of these companies are still in existence and continue to 
transact business along the same general lines as at first, 
namely, what is known as perpetual insurance. This, in 
brief, is a deposit of a certain percentage of the face value 
of the policy which is paid once for all, the interest on it 
proving sufficient to provide for the losses sustained. In 
1794 the Baltimore Equitable Society, operating upon 
the same general plan, was established. 

In December, 1792, the General Assembly of Pennsyl- 
vania was petitioned for permission to incorporate the 
Insurance Company of North America, and on April 14, 
1794, the incorporation of the company was authorized, 
and almost immediately thereafter that of the Insurance 
Company of the State of Pennsylvania. Both of these 
companies were organized to transact marine insurance, 
but during the first year of the North America's existence, 
the directors concluded to add the business of fire insur- 
ance, and the proposals for insurance were completed in 
the latter part of the year. The proposals were for insur- 
ing full value. Two general hazards were provided for; 
the first class including common insurances and providing 
for brick or stone houses, stores and furniture or mer- 
chandise therein, while the second included those houses 
which were not wholly brick and stone and such extra 
hazardous goods as pitch, tar, turpentine, etc. For the 
first class the rate was thirty cents per hundred on an 
eight thousand dollar policy and forty-five cents on a 
policy not exceeding sixteen thousand dollars; while in 
the second class the rates were seventy-five cents per 
hundred dollars. 

The earliest company in New York, of which we have 
any record, was the Knickerbocker Fire, organized April 3, 
1787, under a deed of settlement. The original title, 



74 YALE READINGS IN INSURANCE 

however, was that of the Mutual Insurance Company, 
the name Knickerbocker not being assumed until May 12, 
1846. The company was by its charter permitted to 
transact fire, marine, and life insurance, and in less than a 
month the New York Insurance Company was organized 
with practically the same privileges. Three years later, 
March 21, 1801, the Columbian Insurance Company of 
New York was organized, and on April 4, 1806, followed 
the incorporation of the Eagle Fire with a capital stock of 
$500,000, and now the oldest New York stock fire insur- 
ance company. Most of the companies in New York 
organized during the latter part of the eighteenth century, 
and the first forty years of the nineteenth century, were 
what are known as special charter companies and, follow- 
ing the development of the day, most of them were organ- 
ized for the purpose of writing marine insurance. Another 
of the early New York companies which is still in business 
is the Albany Insurance Company, which was organized 
in March, 1811. The charters of most of the companies 
of this day were what are known as limited charters. 
Some of them were for twenty years, some for thirty, but 
the principle of limitation was quite generally and dis- 
tinctly recognized. 

Commerce early became an important part of New 
England development, and most of the towns were 
seaports or situated at the head of navigation on the 
more important rivers. As soon as the New Englander 
began to trade, he recognized the hazards which attended 
the transportation of merchandise. No sooner was this 
recognized than marine insurance in its earlier forms made 
its appearance. The marine companies in New England, 
as in other parts of the country, issued fire insurance 
policies as soon as there was a call for them. Fire insur- 
ance, however, did not seem as important as marine 
insurance, and the stronger of the early insurance com- 
panies devoted more of their attention to water-borne 
merchandise. In 1799 there was organized at Providence, 



FIRE INSURANCE IN THE UNITED STATES 75 

the Providence-Washington, which still continues to do 
a prosperous business. 

The early underwriting in Connecticut, as in the other 
colonies, was generally of a personal or partnership charac- 
ter. It should be remembered that the country in the 
last decade of the eighteenth century was poor. Its 
capital had been very largely exhausted by the Revolu- 
tionary struggle, and enterprises which had been prosper- 
ous had been completely disorganized, and during the whole 
period of the confederacy the uncertainty of the future 
paralyzed to a large extent the commercial life of the 
colonies. The industrial life of Connecticut was simple; 
coarse articles for necessary use were manufactured, and 
the surplus products of agriculture and merchandise of 
home manufacture were exported to the West Indies. In 
1792 the Hartford Bank and the Union Bank of New 
London were organized, and with the business develop- 
ment which followed the organization of these institutions 
insurance partnerships came. Thus, in 1794, Sanford and 
Wadsworth opened an office in Hartford for insuring 
furniture, merchandise, etc., against fire, and the next 
year associated with themselves Jeremiah Wadsworth, 
John Caldwell, Elias Shipman, and John Morgan in a 
copartnership under the title of the Hartford and New 
Haven Insurance Company for the purpose of insuring 
vessels, stock, merchandise, etc. In 1797 Elias Shipman 
established a separate office in New Haven which was 
chartered as the New Haven Insurance Company, but 
which retired in 1833. The men interested in these 
insurance ventures, for they were ventures, were the mer- 
chants of the leading cities, Hartford taking and holding 
a commanding position. Jeremiah Wadsworth, one of 
the leading spirits in the mercantile and financial life of 
Hartford, was well known outside of that state, since, for 
example, he was one of the founders of the Bank of North 
America of Philadelphia in 1781, holding one hundred 
and four shares of the original stock. In 1785 he was 



76 YALE READINGS IN INSURANCE 

elected president of the Bank of New York, and was also 
interested in the organization of the Hartford Bank. 
This note of Colonel Wadsworth is given so that the charac- 
ter of the men who engaged in early Connecticut under- 
writing may be understood, and the reason seen why 
Hartford has always held such a prominent position in 
the underwriting world. It is because men of brains, 
means, and faith established the business. 

As these partnership policies involved a great deal of 
labor the organization of a corporation seemed a very 
natural step, and in 1803 a charter was procured for 
the Hartford Insurance Company. The business of this 
company was marine and the capital was $80,000 in shares 
of $40 each. Twenty-five per cent, was paid in notes and 
75 per cent, in notes secured by mortgages. But in 1825 
the company was merged in the Protection Insurance 
Company. About this time also, a group of companies 
was organized for the purpose of writing marine insurance, 
but most of them were obliged to go out of business on 
account of the depression in marine commerce consequent 
upon the War of 1812. Some idea of the paralysis of 
commerce of the United States caused by the embargo 
and non-intercourse acts is to be gathered from the fact 
that exports fell from $110,084,207 in 1807 to $22,430,960 
the following year. Duties on imports at New London 
shrunk from $201,838 in 1807 to $22,343 in 1810. Most 
of the marine companies were killed as a result of the 
depression. The Norwich was saved by changing its 
business to fire insurance in 1818 and, as noted above, the 
Hartford was transformed into the Protection. 

The oldest fire insurance company in Connecticut is 
the Mutual Assurance of the city of Norwich, which was 
organized in May, 1795, under a deed of settlement. The 
company has never attempted to do a large business, 
being largely a neighborhood affair. In 1810 the Hart- 
ford Fire was organized and is thus the oldest stock fire 
insurance company in the state. The original capital 



FIRE INSURANCE IN THE UNITED STATES 77 

was $150,000, with privilege of enlargement to $250,000. 
The subscribers were obliged to pay in 5 per cent, in thirty 
days and 5 per cent, more in sixty days, the remaining 
90 per cent, to be secured by notes and mortgages. There 
was not a great deal of money to be had in those days, 
consequently notes and mortgages had to form the prin- 
cipal basis of corporate organization. The organizers of 
this company had everything to learn, because they knew 
nothing about fire insurance, for there was not much 
to be known. It was chance, pure and simple. There 
were no data by which the cost and the charge could be 
brought into anything like proportionate relations. Some 
idea of rates may be gathered from the charges on a few 
of the early policies. Number one was a builder's risk 
of $4000 for three months at twelve and a half cents. 
Number five was $10,000 on a gin distillery at 1J per cent. 
Numbers twenty-one and twenty-two were $20,000, being 
respectively on a stock of drygoods and hardware, the 
former at seventy-five cents and the latter at twenty-five 
cents. The year after the company organized, it began 
to plant agencies, but without any system. For instance, 
there was one agency at Canandaigua, N. Y.; another at 
Middlebury, Vt., and by 1820 an agency had been estab- 
lished at Cleveland, Ohio. As showing the relative im- 
portance of cities and towns, it should be noted that it 
was not until 1821 that an agency was established in New 
York City. The compensation was a sort of graded com- 
mission, determined by the importance of the town. 
Three of the agents were given 10 per cent, on all premiums 
received exceeding $1000 for any one year, while in the 
early years some gratuities were voted by the directors 
to those who had rendered special services. The president 
received no salary until 1823, when he was paid $200 per 
annum, voted semi-annually after the work had been 
done. 

The first secretary of the Hartford Fire, Walter Mitchell, 
did not live in Hartford, but in Wethersfield, and appears 



78 YALE READINGS IN INSURANCE 

to have suited his own convenience as to office hours. 
His convenience was not exactly the convenience of the 
citizens of Hartford, and so in 1819 the iEtna was organ- 
ized, with a capital of $150,000 with the privilege of increas- 
ing it. The first policy of the iEtna was issued August 7, 
1819, and about a month later the first reinsurance known 
in this country was entered into by the iEtna when it 
assumed all of the outstanding risks of the Middletown 
Fire. It rather liked the experience apparently, because 
three years later it was willing to reinsure the New Haven 
Fire, which reinsurance, however, was secured by the 
Hartford. In the beginning of the fire insurance business, 
the matters which are now sent to trained experts were 
considered by the board. The vital portions of each 
policy with the survey were read to the board of directors 
before delivery. The officers and directors did quite a 
little traveling or exploring, and on these trips, made 
from time to time, agents were appointed, which was the 
principal work of a fire underwriter when traveling in 
those days. In 1822 the directors of the iEtna voted the 
secretary two dollars per day and his expenses when he 
went out to establish agencies; while he was drawing his 
per diem allowance, however, his salary as secretary was 
suspended, since they did not believe in paying for work 
which was not performed. The secretary, however, did 
not do all of the pioneering work, much of it being done 
by the directors. 

The pluck of these early underwriters is well illustrated 
by the action of the iEtna directors in the matter of set- 
tling the losses incurred by the great fire of 1835 in New 
York. The Etna's losses amounted to $115,000. The 
directors were notified that the fire would probably exhaust 
the entire resources of the company, and one of the direc- 
tors asked President Brace what he intended to do. " Do? " 
he replied, "go to New York and pay the losses if it takes 
every dollar there," pointing to the securities of the com- 
pany, "and my fortune besides." The directors pledged 



FIRE INSURANCE IN THE UNITED STATES 79 

him their support and the losses were paid. The pre- 
mium receipts increased so rapidly that in twelve months 
the JEtna, had as much cash as before the fire. It was 
the same spirit which led the shareholders to contribute 
$2,500,000 to maintain the technical solvency of the 
company after the Chicago and Boston fires. The success 
of institutions with such men in charge is assured when 
they take hold. 

Until the close of the century there had been about 
ten mutual and four stock companies, organized in the 
country, while by 1820 this number had increased to 
seventeen stock companies in New York, six in Pennsyl- 
vania, two in Connecticut, and one each in Rhode Island, 
New Jersey, and Massachusetts. Of these, twelve are still 
doing business. It should be noted here that very early 
in the history of the business an attempt to exclude 
foreign insurance companies was made. Statutes were 
enacted in Pennsylvania and New York in 1810 and 1814 
respectively, forbidding foreign companies to transact 
business in this country. These prohibitory statutes 
continued in force until after the great fire in New York 
in 1835, which rendered necessary the enlargement of 
the sources from which fire insurance indemnity might 
be secured. Most of the early companies transacted both 
fire and marine insurance. As the business of the country 
developed, the people began slowly to recognize the im- 
portance and necessity of fire insurance, though for many 
years the growth of public recognition was slow. The 
burden of the fire loss in the smaller communities was 
quite largely borne by voluntary contribution. A man's 
house or barn was burned and the owner's neighbors 
made up a purse which should enable him to rebuild, or 
help him, at least, to get a new start; and in some portions 
of the country this practice obtained until past the middle 
of the nineteenth century. In some of the municipalities, 
ordinances were enacted which compelled owners of 
property to have and keep in repair leathern buckets. 



80 YALE READINGS IN INSURANCE 

Some idea of the slow development of the business can be 
gathered from the fact that while the Insurance Company 
of North America decided on its form of fire insurance 
policy in November, 1794, it had, one year later, issued 
only seventy-three policies. In 1796 this company 
decided to accept risks in any part of the United States, 
if the premiums were adequate to the risk in the opinion 
of the officers, and in that year it had risks on its books in 
Western Pennsylvania, New Jersey, New York, Massa- 
chusetts, Delaware, Maryland, Virginia, North and South 
Carolina. In 1798 it declined an application from an 
agency in Charleston, S. C, but in 1807 the company 
decided to authorize agents. There was quite a rapid 
growth of companies during the first thirty years of the 
nineteenth century, which companies, as a rule, were 
purely local, there being only one here and there which 
transacted any business to speak of, outside of the cities 
where it was located. There was but little security behind 
the policies issued beyond the current receipts and the 
good faith of the men who managed the companies. 

The great New York fire of 1835 swept out of existence 
most of the New York companies. This fire closes what 
may be termed the first period of American fire insurance, 
a period devoted almost wholly to pioneering. While 
many of the corporate ventures were failures, still the 
lessons of the period pointed the way to the more perfect 
development which was to follow. Mistakes were dis- 
covered and steps taken to correct them. A question asked 
of Edwin G. Ripley, for example, led to the classification 
of risks. One of the patrons of the company, noticing 
the frequency of fires in certain lines of business, asked 
Mr. Ripley if the Mtna, made money on paper mills. The 
question was a poser, but he straightway began to get 
ready to answer the next man, and so started the classi- 
fication of risks several years in advance of his competitors. 
At this time, also, fire insurance in the large cities had 
become a recognized factor in commercial life. Outside 



FIRE INSURANCE IN THE UNITED STATES 81 

of the cities, however, it was looked upon with more or 
less distrust, or perhaps it might be said was considered 
unnecessary. 

Turning our attention to the second period we find new 
factors entering the buisness. The public demanded 
more certainty in the matter of the contracts and greater 
provision for the stability of the companies, so in 1837 the 
first step was made in the direction of reservation. The 
State of Massachusetts provided that companies should 
maintain a fund to insure their contracts being carried 
out, and this was the beginning of what is known as the 
unearned premium fund. The start toward this is an 
important factor in development as it marks the beginning 
of two things: First, making sure that the policy-holders 
shall be protected in the contracts they have entered into 
with the companies; and second, the entrance into the 
fire insurance field, of the state, which, from this modest 
beginning as will be seen later, has gradually developed 
the extensive system now known as state supervision. 

The development of this idea of reservation is interest- 
ing, especially in view of the fact that it is recognized 
to-day as one of the corner-stones of successful fire under- 
writing. In 1853 the New York legislature enacted a 
law providing for what is known as the unearned premium 
reserve. By the terms of this law, a reinsurance fund 
ranging from about 30 to 60 per cent, of the unexpired 
premiums was required to be maintained. The sum thus 
set aside, which became a liability, was assumed to be 
sufficient to reinsure in a solvent company the unexpired 
risks of a company which desires from any reason to retire 
from buisness. The legislature tinkered with the law in 
1862, providing for the reservation of the full amount 
of the unexpired premiums in all cases where dividends 
exceeding 10 per cent, were paid. The companies con- 
sidered this a burden and sixty companies petitioned the 
legislature to change the law requiring 100 per cent, reser- 
vation to one fixing the percentage at 50 per cent, of the 



82 YALE READINGS IN INSURANCE 

premiums. The New York insurance department opposed 
this request, and justified its opposition by figuring out 
from the loss record that a 50 per cent, reinsurance fund 
was inadequate. This subject of reservation and divi- 
dends was also discussed by the Massachusetts supervising 
officials, and in the ninth annual report of the Massachusetts 
insurance department it was proposed to establish what 
was known as a "state guarantee' ' by which the com- 
panies should pay an annual tax. There were to be three 
classes under this scheme; the first, where less than two 
million dollars of risks were insured, the dwelling-house 
tax was to be five cents on every hundred dollars insured 
and ten cents per hundred on other buildings and personal 
property; the second class, where the amount at risk was 
between two and six million dollars, was to pay a tax of 
two cents and four cents per hundred at risk; and the third 
class, where the amount at risk was over six million dollars, 
the tax was to be one-half cent and one cent on each 
hundred dollars insured. This shows the experimenta- 
tion indulged in by state departments for the purpose of 
getting the business upon a sound loss-paying basis. In 
these early days of state supervision, companies desiring 
a license were examined by special commissions. The 
requirements were slight, and not infrequently the com- 
panies of this period were obliged to go out of business 
within a few years after organization. When the condi- 
tions which existed in the fifties and sixties are compared 
with those of the present day, it will be seen that the 
evolution of the business has been steadily toward cer- 
tainty so far as the policy-holders are concerned, though 
no means have been devised to prevent the capital invested 
from being dissipated through bad management and exces- 
sive losses. 

Another feature of the second period was the develop- 
ment of the mutual idea. The New York fire of 1835 
destroyed a great majority of the New York companies. 
This created a feeling of distrust in the public mind, and 



FIRE INSURANCE IN THE UNITED STATES 83 

the organization of mutual companies became the order 
of the day, and by 1853 sixty-two companies reported 
to the comptroller of New York, having an aggregate 
capital of over eleven million dollars. The mutual plan 
commended itself to the people of that day as correct 
theoretically and economical in operation. In practice, 
however, these companies proved unsatisfactory for the 
reasons that they were based upon incorrect principles 
and because of a lack of staying power. One of the 
weaknesses of the mutual plan in practice is admirably 
stated in the report of James M. Cook, comptroller of 
New York in 1854, in which he says: "The formation of a 
mutual insurance company upon a proper and sound 
basis never contemplated the taking of risks in other 
states than our own." 

The mutual companies had attempted to operate upon 
the same basis as the stock companies did. The mortality 
among the mutuals, however, was excessive. A general 
insurance law was enacted in 1849, and during the suc- 
ceeding four years over fifty-four mutual companies were 
organized. By 1860, however, only seven of these sur- 
vived, and Superintendent of Insurance, Barnes, of New 
York, estimated that the losses to the people through the 
failure of these forty-seven companies averaged at least 
$50,000 per company. These companies were organized 
with premium notes as capital in amounts far exceeding 
the ordinary and legitimate premiums to be charged in 
the regular course of business. The second error was that 
of permitting mutual companies to issue both mutual and 
cash policies. These mutual waves have gone over the 
country at irregular intervals ever since, and in each in- 
stance the original experience has been duplicated to a 
greater or less extent. 

Two forms of mutual companies have persisted. One, 
township mutuals, which as long as they confine their 
operations to a small territorial area, where every person 
knows every other person, aid in the distribution of the 



84 YALE READINGS IN INSURANCE 

fire loss of a given country community and serve their 
purpose well. Where they branch out and attempt to do 
a village and city, or general business, failure is inevitable. 
The second form of mutual development is that typified 
by the mill mutuals. These are based upon knowledge, 
inspection, and improvement. They have, however, in 
all cases ultimately failed as mediums for transacting a 
general fire insurance business. 

The companies gradually recovered from the blow of 
the New York fire and in a few years additional companies 
had started so that the number of companies was in a 
measure commensurate with the growing business of the 
country. There were a large number in New York, Phila- 
delphia, and Boston, and there were companies in other 
cities where there was enough local business to warrant. 
These companies served the business of the country well, 
as a whole, and only began to retire as the development 
of the country's business interests, consequent upon the 
development of the railway system and the telegraph, 
gave the company doing a general business a decided 
advantage over the one doing a local business. In this 
period also state supervision took a definite form in the 
shape of the establishment of departments by New York 
and Massachusetts and gradually by other states. At- 
tempts were also made to devise a more nearly uniform 
fire insurance policy. Up to this time, and for a con- 
siderable time thereafter, each company devised its own 
policy contracts. It took what seemed to be good out of 
the English policies, clipped from its neighbors, and as 
one man with much experience said, this was, so far as 
policies were concerned, the period of scissors and paste 
pot. 

The agents and the companies, principally the com- 
panies, in some of the large cities, formed local boards 
during the fifties. These boards, dominated mostly by 
local companies, were the forerunners of the present 
system of organizations of local agents, but were ma- 



FIRE INSURANCE IN THE UNITED STATES 85 

terially different because they were largely experimental. 
Out of this local board movement also grew an agitation 
for better fire protection, and thus while in the early his- 
tory of the country nearly all the fire departments were 
volunteer, paid departments gradually became the rule, 
and the companies established protective departments for 
the protection of damaged stocks so that the loss might 
be lessened through care. The successors of these depart- 
ments are the fire patrols of to-day. Some facts concern- 
ing these early local boards may be of interest. In 1819 
an organization was formed in New York, known as the 
Salamander Society, the members of which were pledged 
not to deviate from established rates of premium. New 
companies were invited to join and, if they refused, were 
to be specially considered, which appears to have been 
understood and acted upon as a threat. This organ- 
ization was of little practical significance, and was fol- 
lowed by another organization in 1826 and another in 
1857, which formed the fire patrol or fire police in 1859. 
Some few attempts were made in the late thirties and 
in the forties towards standard rating, but merely 
amounted to a faint foreshadowing of the system which 
is being striven for to-day. The record of the New York 
board is typical of most of the local boards of the earlier 
day. 

Another step in the progress of this period was the 
employment of special agents, better known as field men, 
owing to the spreading out of companies which did busi- 
ness in other places than the immediate vicinity of the 
home office. The strictly local company could supervise 
and care for its business through employees of the home 
office. When distances, however, became too great for 
this class of employees, men had to be employed for this 
special work of looking after the field. At first, the greater 
part of the work of special agents was the adjustment of 
losses, though they paid some attention to the agencies, at 
times inspecting risks and authorizing rates. The period 



86 YALE READINGS IN INSURANCE 

under review was one when the West was being settled, 
and the foundation laid for the magnificent development 
of the latter half of the nineteenth century. These pio- 
neers with their poorly constructed and rapidly-growing 
villages and cities, soon felt the need of fire insurance. 
Yet the Middle West, or as sometimes termed, "beyond 
the Alleghanies, ,, was almost an unknown land, and the 
ignorance of the East persisted long after the canal boat, 
river steamer, and railway had begun to open this region. 
In the history of the early days of insurance in Con- 
necticut, attention was called to the fact that the Hartford 
Insurance Company, organized in 1803 to write marine 
insurance, was merged in 1825 with the Protection, organ- 
ized to write a fire insurance business. The secretary of 
the Hartford became the president of the Protection, 
while the secretary of the Protection, Thomas Clap 
Perkins, had much to do with the pioneering work of the 
Protection. Ephraim Robins, a merchant of Cincinnati, 
saw a notice in a Hartford paper that the Protection had 
been formed. Having lost most of his property in a 
cyclone, the importance of insurance was presented in 
a very forceful way to the mind of Mr. Robins. He came 
to Hartford, presented the claims of the West in such a 
way that the company authorized the establishment of a 
western department with Mr. Robins as general agent. 
This was in 1825, and the task of planting the agencies of 
the company in Ohio and other western states was imme- 
diately started. The company's office was a sort of head- 
quarters for prominent Whig politicians, and also proved 
to be a training school for some of the brightest and most 
successful men in western fire insurance. The western 
department of the Protection was the beginning of the 
American agency system on anything like a large and com- 
prehensive scale. The business grew rapidly and when 
Mr. Robins died in 1846, the premiums collected by the 
agency amounted to three million dollars. From the 
western office of the Protection went the forerunners of 



FIRE INSURANCE IN THE UNITED STATES 87 

the modern special agent or field man. The Protection 
eventually failed because it did not build up a large enough 
surplus, and its officers did not really know where the 
company stood owing to a lack of systematic knowledge. 
Following the Protection, the Insurance Company of 
North America and the iEtna made the venture into the 
territory west of the Alleghanies, the former locating at 
Erie and the latter at Cincinnati. The failure of the 
Protection gave a great impetus to the development of 
the western department of the iEtna, as it was in the field 
and ready to make the most of the opportunity offered. 
In 1853 J. B. Bennett became general manager of the 
Mtna, and took charge of the western business. The same 
year that he took charge of the ^Etna's affairs, J. B. Bennett 
prepared a blank proof of loss. Before this time these 
proofs had been written out on the occasion of each adjust- 
ment. This was a waste of time from Mr. Bennett's 
standpoint and so he prepared a form which, in its essen- 
tial features, has not been changed since. The Hartford 
began to send out numbered policies in 1864. These 
companies employed special agents, who, working under 
conditions hard to realize to-day, went up and down the 
country, appointing agents, inspecting towns, and settling 
losses. Indeed the fire insurance business is greatly 
indebted to these men for their faithful labor. Many mis- 
takes were made in this period, because there was little 
cooperation, but still there was a gradual approach 
toward better conditions and a larger and more compre- 
hensive development. Nearly, if not all, of the com- 
panies organized during the first period made the mistake 
of dividing too large a proportion of the profits, and thus 
not leaving enough money to meet the drain of heavy 
losses. When a big fire occurred the companies found 
themselves in a difficult situation and several times it 
was only by guaranteeing by the directors of their personal 
fortunes that a company was enabled to survive. This 
tendency of keeping up dividend payments at the expense 



88 YALE READINGS IN INSURANCE 

of surplus continued well past the middle of the nineteenth 
century, and the importance of maintaining a good work- 
ing surplus was not fully realized until after the Chicago 
and Boston fires. In 1864 the superintendent of the 
New York insurance department, in his annual report, 
declared that several companies were accustomed to 
declare dividends without making any provision at all 
for outstanding risks. Legislative provision was made 
in New York to prevent this, as in 1849, it was enacted 
that "no dividend should ever be made by any company 
when its capital stock was impaired or when the making 
of the dividend would have the effect of impairing its 
stock, and any dividends made in violation to such sec- 
tion subjected the stockholders to an individual liability 
to the creditors to the extent of the dividend so received." 
Still they continued the practice of declaring such divi- 
dends until forced by the hard school of experience to 
transact their business upon business principles. 

The third period of fire insurance development begins 
practically with the close of the Civil War. This may 
be termed the period of cooperations. Conditions were 
very unsatisfactory, rates were low, and prosperity for 
the companies was not very apparent. Hence, in 1866, the 
fire insurance companies of the country organized the 
National Board of Fire Underwriters, and for the next 
ten years it was the controlling factor in fire underwriting, 
and marks the most important change which had so far 
been brought about in the fire insurance business. Its 
purpose was to bring about a cooperation between the 
companies upon matters of common interest and to insure 
adequate rates and proper forms. At this time there were 
a very large number of local companies and quite a num- 
ber of what are best classified as agency companies. 

Three new factors came into the fire insurance business 
about this time : First, the daily report, devised in 1867 to 
facilitate the transaction of business, gradually took the 
place of the old monthly statement, but was slow in win- 



FIRE INSURANCE IN THE UNITED STATES 89 

ning favor with underwriters since some of the managers 
preferred the old form of reporting as being more satis- 
factory. The original form of the daily report, devised 
by Alexander Stoddart, has not been materially changed 
with the passing years. The idea was to select good men 
in the different towns as representatives, have them 
examine the property upon which insurance was sought 
and send in a daily report, containing the written portion 
of the policy and diagram of its exposures, the rate, terms, 
etc.; in fact, a practical reproduction of the descriptive 
part of the policy. This was sent to the home office, the 
agent at the same time, writing and issuing the policy. 
If the company did not care for the risk, it notified the 
agent and the policy was withdrawn. This departure 
placed a very great responsibility upon the local repre- 
sentatives since they virtually passed upon the business 
of the company and most of them, be it said to their credit, 
served their company most faithfully. This plan was 
popular and was gradually adopted by all the companies. 
It is one of the great foundation stones of the modern 
agency system. 

Out of this idea of a daily report grew two others. The 
first one was to have some means of keeping the home 
or branch office in touch with the agents, and also afford- 
ing the company an independent source of information 
concerning the character of the business written. For 
this purpose, the special agent had the scope of his employ- 
ment widened beyond the mere adjustment of losses. He 
traveled around among the agents, appointed new agents 
in desirable territory, secured an idea of the larger risks 
and special hazards of the towns he visited, saw to it that 
the agents kept their monthly accounts paid up and, 
generally speaking, was the hand of the company in the 
field. Soon the incompleteness of the information fur- 
nished the home or branch office as to the physical charac- 
ter of the risks and their environment presented a problem 
which had to be solved. To solve this, the special agents 



90 YALE READINGS IN INSURANCE 

made diagrams of the towns they visited and marked 
upon them the risks of the company. Originating in the 
^Etna's western office, but antedating this period a little, 
was the business of making maps. On the first of May, 
1856, William H. Martin, a civil engineer, was employed 
by the iEtna to make maps of important points where 
the company was transacting business, and in June of 
the same year the first map was copyrighted in the name 
of the iEtna Insurance Company. One of Mr. Martin's 
assistants, D. A. Sanborn, saw the possibilities of the map 
business. He removed to New York and tried to induce 
Mr. Martin to join him, but the latter preferred to remain 
with the Mtna, and did so until his death in April, 1903. 
These maps made it so much easier to transact the busi- 
ness of the company that a considerable demand was created 
for them, resulting in the almost universal use of what are 
known as the fire maps. The large towns and cities are 
mapped, and the map company keeps them up to date, 
supplying the insurance company with all the changes. 
The map department of the modern fire insurance com- 
pany is one of its most important adjuncts. It enables 
the daily report examiner or manager in the office to know 
accurately about the character of the risk he is to pass 
upon. The amount which the company has in any block 
is marked on the map, so that at a glance it is possible 
for the company to decide whether it desires to increase 
its holdings. Before the use of maps, however, all of the 
risks of the company were marked, and a record of the 
company's holdings were kept on what are known as block 
sheets. These enabled the company to know the amount 
it had at risk, though they did not furnish information 
as to environment such as the modern fire map gives at a 
glance. These three devices gave the business a wonder- 
ful impetus. An old underwriter, for example, states 
that one of the great advantages secured through the use 
of the daily report was that the frequency of the knowledge 
prevented stealing on the part of agents through writing 



FIRE INSURANCE IN THE UNITED STATES 91 

short-term insurances which were not reported. This 
underwriter estimated that his office saved at least 12 per 
cent, through the increased frequency of knowledge con- 
cerning the writings of the local agents. 

Belonging to this third period, but really beginning with 
the closing years of the second period, was the opening 
of the Pacific coast to the business of fire insurance. The 
Phoenix, of Hartford, was the pioneer. The officers of 
the Phoenix visited the Pacific coast, looked over the 
ground and on May 1, 1862, established a Pacific coast 
department in charge of R. H. Magill. At this time, all 
the fire insurance business of the coast was written at 
San Francisco through correspondents. The company 
had a correspondent in a town, information concerning 
the risk and the amount desired was sent in, the policy 
issued and forwarded. This was rather cumbersome and 
slow, so in 1863 Mr. Magill began the establishment of 
local agencies in the towns of the coast. His success was 
so great that other companies were obliged to follow his 
example. 

The National Board of Fire Underwriters was just 
beginning to wrestle with some of its difficult problems 
when along came the Chicago fire and wiped out many 
of the insurance companies of the country. Many of the 
purely local companies were caught through the surplus 
lines they wrote or the reinsurances which they secured 
from the agency companies. The companies had only 
partially recovered when along came the Boston fire and 
completed the wrecking of a large number of the fire com- 
panies which had been struggling along in a crippled con- 
dition during the year intervening between the two fires. 
The National Board now promptly took hold of the situa- 
tion, and rates were sharply advanced. State boards and 
local boards in smaller towns were organized and an elab- 
orate system of control was worked out; in fact, in the 
long run, it was too elaborate. These fires imposed upon 
the National Board not only revision of rates, but also 



92 YALE READINGS IN INSURANCE - , 

problems of construction. Chicago had been a wooden 
city, Boston had also much wood in its construction, and 
the dangerous mansard roof was then in the heyday of 
its popularity. A determined crusade was therefore made 
against these forms of construction, and the preparation 
of a basis or schedule for rating was attempted at this time. 
There was also a large influx of new companies as a result 
of the increased rates following the Boston and Chicago 
fires. 

In 1874 the companies doing business in New York 
were compelled to report their unearned premium lia- 
bility, and to this period also belongs the adoption of the 
safety fund law in New York. The increase in the num- 
ber of companies, and the profit which attended the busi- 
ness because of the increased rates, induced a period of 
demoralization which extended from 1874 to 1880, during 
which numerous irresponsible companies were formed. 
To make matters worse, the National Board, in April, 1877, 
stopped making rates and relegated this subject back to 
the local boards, with the result that the high rates could 
no longer be maintained. Every company was a law unto 
itself; there was no profit, and it was apparently a struggle 
for the survival of the fittest. The fire insurance business, 
however, had become so large that this demoralization 
could not be permitted to continue. Some method of 
cooperation had to be found, and this begins the last 
period of this study. It should be noticed here that fire 
insurance had been going through an evolution, and step 
by step the scope had become broader and better cal- 
culated to assist the business development of the country. 
New ideas and new doctrines had come to the front as 
necessity compelled. The rating by the National Board, 
through its state boards and local boards, had been so 
much of an improvement over the former conditions that 
things could not be permitted to go backward. Some- 
thing new, however, had to be devised. 

In the eighties, the field man proved the way out. He 



FIRE INSURANCE IN THE UNITED STATES 93 

had been doing his work quietly and unobtrusively, and 
the main difficulty had been lack of numbers and too large 
territory to oversee. The abdication by the National 
Board of its rate-making powers threw a large amount 
of additional work upon his shoulders. Accordingly, in 
1872, the New York State Association of Supervising and 
Adjusting Agents was organized; in 1881, the Underwriters' 
Association of the Middle Department; in 1883, the Under- 
writers' Association of New York State and the New Eng- 
land Insurance Exchange; in 1882, the Illinois State Board 
of Fire Underwriters — all of which may be considered as 
pioneers in the attempts at cooperation. Into the hands 
of these associations the detailed work of rate-making was 
given. Upon them also fell the work of readjusting the 
local boards, so that the chain of cooperation might be 
complete. The local agents, then the special agent, and 
the problems which they could not individually adjust, 
were sent to the field men's organization and the residue 
of problems was sent up to the organizations of the com- 
panies. Two of these organizations were formed about 
this time, namely, the Western Union in 1879, and the 
Southeastern Tariff Association in 1882, while the Fire 
Underwriters of the Pacific had been in existence since 
1870. The Western Union and the Eastern Union are 
now the managing underwriter's medium of cooperation 
in the territory east of the Rocky Mountains, while the 
Pacific coast is under another organization. An outgrowth 
of the National Board should be mentioned here, namely, 
the Fire Underwriters' Association of the Northwest. 
When the National Board gave up its rate-making func- 
tion the Northwest Association became simply a social 
and educational association of the western field men, and 
has increased from year to year in power and influence, 
until it is the leading social and educational association 
of the field men in this country. 

One of the first practical problems of this period was 
that of policy forms. There had gradually grown up a 



94 YALE READINGS IN INSURANCE 

fairly satisfactory policy in some sections, but it was 
purely a local policy. Every city and every section used 
one that was a little different. Then again, the companies 
did not cling as closely to one form as they might and, as a 
result, in adjustments there were conflicting forms. In 
reality it was difficult under those various forms to deter- 
mine the liability of the corporation. The National Board 
adopted a standard policy, but it did not make much 
progress, and finally, in 1873, Massachusetts provided for 
a standard policy, which was made obligatory in 1880 
upon all companies operating in that state. In 1886 New 
York adopted a standard form of policy which became 
mandatory in January of the following year, and which 
is now in use in all the states where there are not special 
forms provided by statute. 

The next step in the evolution was in the matter of 
inspections. The mill mutuals, as certain New England 
companies are styled, were organized under the theory 
that it was cheaper to prevent fires than to pay losses. 
Therefore they developed a very thorough system of 
inspection and the use of fire preventive appliances. 
Chief among these fire preventive appliances are what 
are known as automatic sprinklers. The early sprinklers 
were not particularly satisfactory, but out of the evolution 
of experience came the modern heads, most widely known 
of which is the Grinnell. The stock companies found it 
necessary to meet the competition of these mill mutuals, 
and so there arose what is known as the Factory Insurance 
Association, organized in 1890. This was followed soon 
after by a similar organization in the West, and these 
organizations make a special feature of inspecting property 
and writing large policies upon such protected and in- 
spected risks. In line with this idea is the spread of fire 
preventive methods. This fire prevention idea includes 
not only sprinklers, but construction, water supply, 
electrical wiring, and numerous other provisions for the 
prevention of fire. The National Fire Prevention Asso- 



FIRE INSURANCE IN THE UNITED STATES 95 

ciation, organized in 1896, has done more to lessen the 
number of fires by means of proper construction than all 
other agencies put together. It has enlisted science, 
architecture, and chemistry in the prevention of fires. 

The rating problem has been and still is one of much 
difficulty. It is hard to build up a system of rates for 
fire risks which shall be equitable and easily compre- 
hended by property owners. The physical character of 
risks varies so, and there is so little harmony in the matter 
of water supply and fire protective appliances in the 
different cities, that the rating problem becomes and is 
many sided. The first systematic plan was devised by a 
committee of which F. C. Moore was chairman, and the 
schedule, known as the Universal Mercantile Schedule, was 
promulgated in 1893. It is the main basis for fire insur- 
ance rates at the present time. In the late nineties, A. F. 
Dean, of Chicago, who had been making a careful study 
of rates, prepared a tariff known as a " Mercantile Tariff 
and Exposure Formula for the Measurement of Fire 
Hazards." It is based upon a diffierent theory from the 
Moore schedule. It is more scientific and flexible and has 
come into quite general use in the Middle West, and bids 
fair, as regards principles at least, to become the basis of 
fire insurance rate-making. 

Legislation affecting fire insurance has grown from 
small beginnings to one of large proportions. Legislation 
touches the fire insurance business at many points. In 
1885 the State of New Hampshire enacted what is known 
as the valued-policy law. This law prevented any ques- 
tioning of the value of the buildings insured and the com- 
panies promptly withdrew from the state . for several 
years. Laws similar to this have been enacted in a num- 
ber of states, with the result of increasing the cost of 
insurance to the buyer. Then adverse legislation has also 
attempted to prevent cooperation between the companies 
through the enactment of anti-compact laws and the pro- 
hibition of certain clauses in policies. The men who levied 



96 YALE READINGS IN INSURANCE 

taxes began soon after the war to realize that the insurance 
business was a good field for their activities, so they began 
to tax premiums, impose fees for filing statements and 
devise other taxes which aggregated a large amount and 
have always been a very material burden. As the needs 
of the states have increased, so the burdens imposed upon 
the companies have increased. In the later development 
of fire insurance, legislation and taxes have been among 
the most serious of the problems to be faced. Despite 
adverse legislation and the disintegrating tendencies of 
prosperity, cooperation has progressed. The companies 
have more and more found themselves unable to stand 
alone. There were so many points where their interests 
touched, so many ways in which they could help each 
other, that cooperation has become a powerful factor in 
the business. 

Another feature of this period was the foundation of 
organizations for adjustment of losses whereby a company, 
when it was not convenient to employ the special agents, 
could secure the service of trained and expert adjusters. 
These organizations do good work and fill a want long felt. 
This was followed in due time by a plan for minimizing 
the expense and increasing the efficiency of adjustments. 
This originated in New York and makes for progress in 
the matter of systematic work. Still another advance 
has been that of salvage wrecking or the handling and 
sale of damaged stocks, an advance which has manifested 
itself both in the form of company organizations and pri- 
vate corporations. 

Despite the many lines of progress, however, there has 
been from time to time the recurring mutual wave and the 
Lloyds craze. The latest of these waves, that of Lloyds, 
has only recently receded. It followed a high tide of 
mutual experiment, neither of these waves evidencing 
any advance in the direction of sound underwriting. 
After the Lloyds wave began to recede, legislation was 
invoked, and only last winter the New York legislature 



FIRE INSURANCE IN THE UNITED STATES 97 

enacted legislation against the vanishing Lloyds form of 
underwriting. Duplication of company power was also 
attempted in 1897 and 1898 in the form of underwriters' 
agencies or the attempt to form two companies out of one. 
They created some discussion and friction, but only a few 
remain and it is questionable how successful they are. 
The latest phase of the business of insurance to be noted 
is that of the organization of the local agents into 
cooperative relations. The agents, like the companies, 
have found that they have many interests in common, and 
that one agent standing by himself does not amount to 
more than one company standing by itself. Having come 
to the conclusion that certain things of vital interest to 
them might be improved, they have formed a national 
association as well as state associations, whose work, as 
a whole, has been a benefit to the business. 

From this historical study the reader will, no doubt, 
have noted the very great advance made in fire under- 
writing since the period when trees were not permitted in 
front of insured property. The evolution has been frag- 
mentary, it is true, and not altogether in an orderly man- 
ner, but it has been a steady evolution nevertheless. 
Starting in ignorance of method, only having an object 
in view, the business of fire insurance has gradually reached 
out, and has more and more found a sure footing. The 
managers have noted where the relations of the business 
demanded changes; conflagrations have brought home 
to them certain truths; and when a form of organization or 
a method of doing buisness has broken down, men have 
been found to come forward to try something new, gen- 
erally an advance over that which had been discarded. 
These men soon realized that the sole business of fire 
insurance was not simply to pay losses. The evolution 
has naturally been gradual up to the point where the 
skilled and capable underwriter recognizes that his busi- 
ness, being a part of public progress, should subserve the 
public interest best by preventing fires. Therefore, he 



98 YALE READINGS IN INSURANCE 

has made concessions in rates for the men who will take 
the extra precautions in the line of building and fire pre- 
vention. His horizon has broadened and he sees that fire 
fighting and construction are closely related in the pros- 
perity of his business. He has learned, but slowly it is 
true, but nevertheless he has learned, that what the public 
desires above everything else is certainty, and while he 
has grumbled many times at the intervention of the state 
in his business, to-day he recognizes that intervention, 
as a rule, makes for the certainty which both he and the 
assured desires. There are many incidents and events in 
the century and a half of fire insurance in this country 
which might have been wisely different, but taken as a 
whole, it has been a sound and progressive development, 
comparing favorably with that of any other line of business. 



CHAPTER V 

FUNCTION OF FIRE INSURANCE * 

The term insurance has been used in describing the 
fund accumulated to meet uncertain losses. It is evident 
that in a static state all producers who are exposed to 
risk must accumulate such funds. While it is uncertain 
whether the accumulation of any individual producer will 
be enough to meet the loss he suffers, that of the entire 
body of producers in any industry must be large enough 
to cover the losses of the group as a whole. Otherwise 
there would be in the long run a great diminution in the 
amount of capital in hazardous industries, and a serious 
disturbance of the static adjustment. Such a phenomenon 
is inconsistent with the notion of the static state. A 
fruit-dealer who at irregular intervals suffers loss through 
decay must add to the price of his fruit enough to cover 
such uncertain loss. A ship-owner has to increase his 
freight rates more or less, if his ships occasionally lie idle 
in port. In this sense, then, every producer, in the absence 
of all opportunity of transferring his risk, must insure 
himself. Such insurance would be denned as the accu- 
mulation of a fund to meet uncertain losses. From the 
point of view of economic theory, the insurance fund 
includes only that part of the accumulation that is 
intended to cover the uncertain part of the loss; it is 
that part only whose amount is affected by the influ- 
ence of uncertainty. 

This individualistic method of providing for uncertain 

1 By Allan H. Willett. Reprinted from "Economic Theory of 
Risk and Insurance," Vol. XIV, pages 387-408, Columbia University 
Studies in History, Economics, and Public Law, 1901. 

99 



100 YALE READINGS IN INSURANCE 

loss is spoken of sometimes as latent insurance/ and some- 
times as seZ/-insurance. The latter term is usually applied 
to such conduct on the part of large concerns with many 
risks of kinds commonly transferred to regular insurance 
companies; the former is more frequently used of the 
preparation to meet risks of kinds which insurance com- 
panies do not assume. While it may be impossible to 
avoid the use of the term insurance in referring to these 
forms of economic activity, it is evident that in common 
usage the word is ordinarily employed in a different sense. 
It is used to denote the transfer of risk. Any person who 
guarantees another against accidental loss of any kind is 
said to insure him. It is in this sense that the capitalist- 
entrepreneur insures the capital of those from whom he 
borrows. This use of the term insurance, however, like 
the preceding, fails to bring out its real significance. To 
apply it to all individualistic preparation for uncertain 
loss extends it too far in one direction; to apply it to every 
transfer of risk extends it too far in another. To form a 
complete conception of insurance, it is necessary to add 
to the notions of accumulation of capital and transfer of 
risks the idea of the combination of the risks of many 
individuals in a group. We should define insurance, then, 
as that social device for making accumulations to meet 
uncertain losses of capital which is carried out through 
the transfer of the risks of many individuals to one person 
or to a group of persons. Wherever there is accumula- 
tion for uncertain losses, or wherever there is a transfer 
of risk, there is one element of insurance; only where 
these are joined with the combination of risks in a group 
is the insurance complete. 

1 " Partout oil il y a un risque a courir, une assurance latente pro- 
tege la valeur ou meme le gain menace" par ce risque. On la retrouve 
dans la commission prelevee par le banquier, dans les prix sureleves 
du marchand qui livre a credit, dans les taux parfois usuraires de 
certains pr6ts." — Michel Lacombe, "Assurances," Say and Chailley'a 
Nouveau Dictionnaire d'Economie Politique, Vol. I, p. 101. 



FUNCTION OF FIRE INSURANCE 101 

In many respects the increase in the number of distinct 
risks that an individual producer carries is analogous to 
the combination of the risks of many individuals. Other 
things being equal, a ship-owner who has a hundred ships, 
and who carries his own insurance, is in the same economic 
condition as any one of a hundred ship-owners, each pos- 
sessing one ship, who have combined their risks in a group 
through a system of insurance. The gain from the com- 
bination of risks is due solely to the increase in the number 
of risks in the group ; and if that increase takes place through 
the growth of a single industry, the same advantage is 
obtained. It is partly because of this fact that large in- 
dustrial concerns are able to carry their own insurance. 
With the increase in the number of distinct risks to which 
they are exposed, the cost of carrying the risk relatively 
diminishes. This gain is one of the influences that foster 
the growth of large industrial organizations. In the 
absence of all other conditions affecting their size, it would 
lead in the end to the concentration of each line of indus- 
try, or even of all lines, in the hands of a single organiza- 
tion; and in the presence of these other conditions, the 
size that would finally be found most advantageous would 
be affected by the increase in the number of risks. 

It is time to point out the exact nature of the gain under 
consideration. It is evident that it will not be due to 
any reduction in the actual amount of positive loss. What 
the increase in the number of separate risks in the group 
does bring about is a reduction of the uncertainty for 
the group as a whole, a substitution of certain loss for 
uncertain loss. As is well known, the probable varia- 
tion of the actual loss in any year from the average for 
a series of years increases only as the square root of the 
number of separate chances of loss included in a group. 
Now, as we have seen, it is through the accumulation 
for meeting uncertain loss that the special reward for 
risk-taking is obtained. Competition will not cut the 
accumulation for this purpose down to the average 



102 YALE READINGS IN INSURANCE 

amount of loss; it leaves a margin of safety. It is evi- 
dent, therefore, that anything that diminishes the degree 
of uncertainty reduces the cost of risk to society. As 
the uncertainty diminishes, the accumulation to meet the 
uncertain loss is brought nearer to the probable loss as 
estimated by the law of averages. If all the uncertainty 
could be annihilated, the accumulation would be limited 
to the exact amount of the foreseen loss, as in the case of 
any other fixed element in the cost of production. 

The application of this principle to the institution of 
insurance is evident at a glance. The risk that an insur- 
ance company carries is far less than the sum of the risks 
of the insured, 1 and as the size of the company increases 
the disproportion becomes greater. It is primarily through 
this reduction of uncertainty that a static society would 
be benefited by the existence of insurance. The cost of 
commodities would be reduced through the diminution of 
that part of the expense of producing them that is involved 
in the necessity of paying for the assumption of risk. The 
nature of this gain may be made clear by a simple illus- 
tration. 

Let us assume that there are 10,000 capitalists of the 
same reluctance to incur risk, each owning a house valued 
at $5000; that all the houses are exposed to the same 
danger of destruction by fire; that the average annual 
loss for a period of years has been 50, and the average 
variation 20; and that the rate of interest in safe invest- 
ments is 3 per cent. If each owner makes an allowance 
of 3 per cent, a year for the amortization fund, what annual 
rental will he demand for his house? 

The uncertainty to which each investor is exposed is 
the resultant of two factors, the average loss and the prob- 

1 "The aggregate danger is less than the sum of the individual 
dangers, for the reason that it is more certain, and that uncertainty 
of itself is an element of danger." William Roscher, Principles of 
Political Economy. Translated by J. J. Lalor. New York, 1878, 
Vol. II, p. 261. 



FUNCTION OF FIRE INSURANCE 103 

able variation. What would be the reluctance of an in- 
vestor to incur the risk in the case assumed, and what 
reward would be necessary to overcome the reluctance, 
are empirical facts that we have no means of discovering. 
It is a conservative estimate that on account of the risk 
each capitalist will demand an extra 1 per cent, on his 
investment. The annual rent will then be at the rate of 
7 per cent., that is, $350 for each house. At the end of a 
decade, if the favorable and unfavorable years just offset 
one another, the group will have suffered a loss of 500 
houses, valued at $2,500,000. This gives an average 
annual loss of $25 for each of the 10,000 investors. Mean- 
time each of them has received $50 a year on account of 
the risk. In the group as a whole the destroyed capital 
has been replaced, and each investor has received a net 
reward of $25. The hirer of the house, who has had to 
pay this additional rent, is not at all concerned with the 
way in which the income has been distributed among the 
different owners. Some of these have suffered losses which 
the $50 a year was not enough to cover; others have escaped 
loss, and the entire $50 represents a net gain for them. 
Each consumer, in this case each house-renter, has had 
to pay $25 a year more than he would have had to pay 
if it had not been for the uncertainty. 

Now let us examine the situation of the same persons 
after a system of insurance has been introduced. We will 
leave out of consideration the incidental expense of the 
insurance itself, and for the sake of simplicity it will be 
assumed that the reluctance of the insurer to assume 
risk is the same as that of the house-owners, and that the 
fact that the houses are insured has no effect upon the 
probability of loss. What is the uncertainty to which 
the insurer is exposed when he is carrying the risk of the 
entire group, and what reward can he obtain for assuming 
it? 

As the average variation of the annual loss has been 20, 
we may assume that a minimum loss of 25 houses for the 



104 YALE READINGS IN INSURANCE 

group is certain to occur each year. The insurer, then, 
has to face a certain loss of 25 houses a year, and a prob- 
able loss, as determined by past experience, of 25 more. 
For the former, the competition of other insurers will pre- 
vent him from obtaining more than enough to replace the 
loss. That will be $125,000 for the group, or $12.50 for 
each house. For the uncertain loss we will assume that 
he will be able to obtain a return of twice the probable 
amount of loss, just as the single investor did, though there 
$ are reasons why he would probably demand rather less. 

That will make this part of his income $250,000 for the 
group, or $25 for each house. Each house-owner, there- 
fore, will have to pay the insurer $37.50 a year, and their 
competition with one another will prevent any one of them 
from obtaining more than that from the person to whom 
he lets the house. The entire rent will now be $337.50 
a year. Each consumer saves $12.50 a year, and each 
capitalist is still rewarded at the same rate as before for 
carrying risk. If these 10,000 houses had been joined 
with a large number of others, so that there were, let us 
say, 1,000,000 in the group, a similar calculation would 
show that the cost of the risk to each hirer of a house would 
be reduced to $26.25 per annum, or only $1.25 more than 
enough to cover the actual loss in a series of years. 

That this gain is in no way dependent on the combina- 
tion of the risks of different investors in one group, and 
that it could equally well be obtained by a single concern 
with an increasing number of risks, is manifest. It is equally 
manifest that it would be advantageous for a person with 
a large number of risks to join them with as many others 
of the same kind as possible. While so-called self-insur- 
ance becomes cheaper as the number of risks increases, it 
would never be as cheap as regular insurance if the insur- 
ance business were rightly managed. If it is cheaper for 
a concern to carry its own risk than to pay premiums to 
an insurance company, it shows either that the company 
considers the risk higher than the concern thinks is right, 



FUNCTION OF FIRE INSURANCE 105 

or that the insurance business is so expensively managed 
that the cost of the management more than offsets the gain 
from the increase in the number of risks. The prevalence 
of the custom of self-insurance against risks such as the 
regular insurance companies assume is a serious reflection 
on the management of the companies. 

The effect of the principle that we are considering on 
the size of insurance companies is the same as that already 
noted in speaking of independent industrial organizations. 
It is a force working towards large companies. The larger 
an insurance company is, the cheaper it can afford to give 
insurance. It might be impracticable, but it would not 
be economically unjustifiable, to require small companies 
to carry higher reserves in proportion to the amount in- 
sured than large companies are compelled to carry. In 
the absence of conflicting influences each branch of insur- 
ance would finally be concentrated in the hands of a single 
company. Nor is there any reason why the process of 
centralization should stop here. There is the same eco- 
nomic advantage in combining risks of entirely different 
kinds, provided they are correctly estimated, as there is 
in combining risks of the same kind. The difficulties in 
the way of such general combinations are all of a practical 
nature. Whatever may be said on the ground of expedi- 
ency for the laws passed by some of our states restricting 
the freedom of insurance companies in the matter of assum- 
ing different kinds of risks, economic theory affords no 
justification for such policy. The more risks the cheaper 
the insurance, is a universal economic principle. One 
enormous company carrying all risks would be the ideal 
organization of insurance 

The gain due to the combination of risks and to the 
consequent reduction of uncertainty is not the only eco- 
nomic benefit of insurance. There is another advantage 
resulting from the transfer of risk, which is of the same 
kind as the one previously noticed in speaking of the capital- 
ist-entrepreneur. It is desirable for society that risks 



106 YALE READINGS IN INSURANCE 

should be correctly estimated. Men differ much in their 
ability to judge them. The segregation of the work of 
estimating risks leads to a differentiation of capitalists, 
as a result of which those who are especially adapted to 
that task will be the ones who will undertake it. More- 
over, their natural ability will be further developed through 
the experience and training of the work itself. On the 
other hand there are many men capable of rendering good 
service to society in comparatively safe industries, who are 
so constituted that the necessity of running any great 
chance of loss seriously diminishes their efficiency. The 
possibility of transferring the risks of their business to others 
for a fixed premium frees them from the paralyzing influ- 
ence of uncertainty, and enables them to make the best 
use of their powers in other directions. The gain to so- 
ciety from the transfer of risks is obtained partly through 
the reduction in the cost of carrying the risks when they 
are borne by those who have the most ability to estimate 
them and the most confidence in their own judgments 
about them, and partly through the increase in the effi- 
ciency of those who are abnormally sensitive to the influ- 
ence of uncertainty. 

The gains of which we have been speaking are partly 
offset by the cost of carrying on the insurance business. 
This cost consists of interest on the capital and wages for 
the labor employed in the actual performance of the work. 
What that cost ought to be, if insurance companies were 
economically conducted, and how far the actual cost ex- 
ceeds that amount, we need not stop to inquire. There 
is a generous margin between the price for which a large 
insurance campany can afford to assume a risk and the 
price which an individual producer would demand for 
carrying it. That this margin is not exhausted even by 
the extravagant methods of management that characterize 
existing insurance companies is proved by the almost uni- 
versal prevalence of the custom of insurance. That it is 
more nearly exhausted than it ought to be is proved by 



FUNCTION OF FIRE INSURANCE 107 

the persistence of the custom of self-insurance. It must 
not be forgotten, however, that insurance companies carry 
on many other forms of activity besides their special work 
of furnishing insurance. Investment is a prominent 
feature of so-called life insurance, and preventive measures 
of various kinds are carried out by insurers of property. 
Insurers of boilers have their inspectors, fire insurance 
companies have their patrols, burglary insurance com- 
panies their private watchmen, and so on through the list. 
The part of the premium which is used in carrying out 
these protective measures ought not to be considered as 
part of the cost of insurance. It is work that would have 
to be done in some form by individual producers or by 
society, if it were not performed by the companies. The 
fact that the companies do it is an indication that it is 
accomplished more cheaply or more efficiently by them 
than it could be by the insured themselves. Another 
legitimate form of expense that ought to be recognized 
is the cost of securing the services of experts in appraising 
property and estimating risks. This work would also 
have to be performed in some way by individual producers 
if they carried their own risks. It might perhaps be ac- 
complished more cheaply by them, but it would certainly 
be done more crudely and inaccurately. The gain from 
the accurate valuation of risks by experts more than 
counterbalances the necessary increase in the expense. 

There is another form of loss of serious proportions which 
must not be left unnoticed in comparing the advantages 
and disadvantages of insurance. It is an essential feature 
of a perfect system of insurance that the occurrence of the 
event for whose economic consequences compensation is 
guaranteed shall never be a source of gain to the insured. 
In an ideally complete system the payment by the in- 
surance company will just equal the loss of the insured. 
Now it is a matter of common observation that insurance 
is often obtained in excess of the actual value of the prop- 
erty insured. As a consequence there is considerable 



108 YALE READINGS IN INSURANCE 

wilful destruction of property for the purpose of obtaining. 
the insurance. Moreover, it is doubtful whether it is 
practically desirable that the amount of the insurance 
equal the full value of the property, since no incentive 
would be left to the insured to guard against the destruc- 
tion of his property. Over-insurance leads to fraud, full 
insurance to carelessness, and even partial insurance to 
some diminution of watchfulness. Whatever increase may 
occur in the amount of positive loss either through fraud 
or through carelessness must be deducted from the dim- 
inution in negative loss in estimating the net gain which 
insurance brings to society. 

The economic significance of insurance in a state is con- 
nected with its influence in reducing the burden which the 
existence of risk imposes on society. So far as the degree 
of risk is lowered, and the reluctance to assume it is dimin- 
ished, so far is society benefited by the institution of 
insurance. How great the gain is, even under existing 
imperfect conditions, it is impossible to estimate, since it 
is difficult to conceive how the large enterprises of the 
present day could be carried on without the possibility of 
transferring to insurance companies many of the risks in- 
volved in them. It could certainly be done only on a 
much larger margin of safety than is now considered 
necessary. 

The essential features of economic insurance as we have 
defined it are the accumulation of capital to meet uncer- 
tain losses, and the transfer and combination of risks. 
Many other conceptions of insurance have been held by 
various writers on the subject. Some originated in an 
over-emphasis of a comparatively unimportant phase of 
the institution, others in a wrong interpretation of some 
feature of it. As an example of the former kind may be 
mentioned the conception of those writers who find the 
significance of insurance in the diffusion of positive losses 
over a large group of persons. 1 That the insured in the 

1 " Considered dans son principe meme, l'assurance est une associa- 



FUNCTION OF FIRE INSURANCE 109 

long run pay all the losses is undoubtedly true, but the 
distribution of the losses is only an indirect result of the 
insurance; it is neither the purpose of it nor the immediate 
consequence. The purpose of securing insurance is to 
avoid uncertainty. The insured buys security by the pay- 
ment of a fixed premium, and after he has bought it his 
condition is not affected by the number of losses which 
the insurer may have to make good. If the number of 
losses increases, the premium rate may be raised; but in 
all cases of complete insurance the cost of it is a definite 
element in the expense of production, the amount of which 
is fixed before the occurrence of the losses. Only in the 
case of mutual assessment companies is there a direct dis- 
tribution of losses over a group. A member of such a com- 
pany is not in the same economic situation as one insured 
for a fixed premium. He has not transferred his risk and 
purchased security; he has exchanged one risk for another, 
usually a small chance of a large loss for a larger chance 
of a smaller loss. Where there is a mere diffusion of loss 
there remains some degree of uncertainty as to the amount 
of loss that each member of the group will suffer; where 
there is complete insurance the insurer has taken upon 
himself the entire chance of loss, so far as concerns the 
risks covered by the insurance. To define insurance, 
then, as the distribution of losses is to make too prominent 
an indirect and comparatively unimportant result of it, 

tion qui a pour objet de repartir entre tous ses membres les pertes 
occasionnees a quelques-uns d 'entre eux par certains evenements 
fortuits, de telle sort que chaque membre supporte sa part de l'indem- 
nite due aux victimes du sinistre." — Ch. Dumaine, " Assurances," 
Say's Dictionnaire des Finances, Vol. I, p. 220. 

" Versicherung im wirthschaftlichen Sinne ist diejenige wirthschaft- 
liche Einrichtung, welche die nachtheiligen Folgen (zukiinftigen) 
einzelner, fur den Betroffenen zufdlliger, daher auch im einzelnen Falle 
ihres Eintretens unvorhergesehener Ereignisse fur das Vermogen einer 
Person dadurch beseitigt oder wenigstens vermindert dass sie diesel- 
ben auf eine Reihe von Fallen vertheilt, in denen die gleiche Gefahr 
droht, aber nicht wirklich eintritt." — Adolph Wagner, " Versicherungs- 
wesen," Schonberg's Handbuch, 4te Auf, 2 Band 2, s. 359. 



110 YALE READINGS IN INSURANCE 

and to leave entirely out of the definition the elements in 
which its ecomomic significance really lies. 

The other erroneous conception of insurance to which 
reference has been made is even more indefensible than 
the one just noticed. Instead of arising from an over- 
emphasis of a comparatively unimportant feature of the 
institution, it is based on an essentially false idea of its 
nature. Because each insurance contract considered by 
itself is a contingent contract, and because the event upon 
which the payment by the insurer to the insured depends 
is uncertain, many writers have regarded insurance as a 
form of gambling. 1 But the resemblance is in reality of 
the most superficial kind. It is not difficult to discover 
the mark of distinction between the two transactions. 
Insurance involves the transfer of an existing risk from 
one person to another; gambling involves the creation of 
a new risk to which neither party to the transaction was 
exposed before the contract, and to which they are both 
exposed after it. If a man insures his factory, he frees 
himself from uncertainty, and the other party to the con- 

1 " Let us now contrast the workings of insurance. In this case also 
the contract is a wager. A house-owner pays an insurance company 
fifty dollars, in return for which he is to receive five thousand dollars 
in case his house burns down within a specified time; just as he might 
pay a book-maker fifty dollars and receive five thousand in case a speci- 
fied horse wins a race." — Arthur T. Hadley, Economics, p. 99. 

"Le contrat aleatoire est une convention reciproque dont les effects, 
quant aux avantages et aux pertes soit pour toutes les parties, soit 
pour Tune ou plusieurs d'entre elles, dependent d'un evenement in- 
certain. Telles sont le contrat d'assurance, . . . le jeu et le pari, 
. . ." — Code civil francais, Art. 1984. Quoted in Charles Berdez, 
Les Bases de V Assurance Privee, p. 56, note. 

"Wenn also der unorganisierte Spiel des Schicksals den Menschen 
in Gefahr bringt, so begreifen wir, dass das Mittel, welches er ihm 
entgegensetzt, ein organisiertes Gliickspiel sein wird. Er erreicht 
dadurch die Wirkung, dass er zur selben Zeit, wo er von eineme Ver- 
lust betroffen wird, durch das Gliickspiel einen Gewinn erhalt, der 
gerade den Schaden deckt." — R. Schlink, Die Natur der Versich- 
erung, Wurzburg, 1887, s. 13. 



FUNCTION OF FIRE INSURANCE 111 

tract assumes it; if he makes a wager with another, his 
own uncertainty and that of the other person are both 
increased at the same time. Undoubtedly in the past 
many transactions which wore the virtuous guise of 
insurance were no better than gambling contracts. If a 
person takes out a policy on property in which he has no 
insurable interest, he virtually makes a wager with the 
insurance company that the property will be destroyed. 
Such contracts are clearly against public policy, and legis- 
lation has done much to limit their number. The courts 
on the other hand have frequently given a liberal con- 
struction to the phrase "insurable interest," and many 
contracts of doubtful legitimacy are still tolerated. A 
legitimate insurance contract, however, may always be 
distinguished from a gambling contract by the principle 
pointed out. Insurance is the transfer of risk, gambling 
the creation of risk. 

After a system of insurance against any class of risks 
has been established, an entrepreneur has a choice between 
three methods of meeting such a risk, in an industry that 
he has decided to enter. He may adopt preventive meas- 
ures, he may obtain insurance, or he may carry the risk 
and pay a higher price for the capital he borrows. His 
selection among these different modes of conduct will 
depend upon their relative cost. Expenditure for any one 
of them is to him an item in the cost of production, and 
he will naturally adopt the one that is cheapest. As a 
matter of fact, in nearly all cases it is necessary to com- 
bine the three methods. Preventive measures are adopted 
by which the total amount of risk is somewhat reduced; 
a part of the remaining risk is transferred to insurance 
companies; the rest is borne by the capital in the industry. 
The amount of the expenditure for each of these purposes 
is determined according to the principles already estab- 
lished. The payment for the capital exposed to risk con- 
tains an element of reward for risk-taking, which is large 
in proportion to the degree of risk; the payment for insur- 



112 YALE READINGS IN INSURANCE 

ance contains a relatively smaller element of the same kind; 
the payment for prevention contains none at all. 

The entire sum paid by the insured to the insurance 
company is called the insurance premium. As the com- 
panies carry on many forms of activity which are not an 
essential part of their business of furnishing insurance, 
and the expense of which is paid out of the premiums 
they receive, the cost of the insurance itself is less than 
the amount of the premium. In a strict economic sense 
the insurance premium includes only that part of the pay- 
ment to the company that would have to be made to in- 
duce it to assume the risk. Expenditures for preventive 
measures, whether made directly by the entrepreneur 
himself, or first incurred by the insurance company and 
then recovered from the insured, are no part of the cost 
of insurance. This distinction, however, is not observed 
by all writers. 1 Because the entrepreneur has a choice be- 
tween prevention and insurance, it seems to be inferred 
that the two forms of expenditure are essentially alike. 
It is evident, however, that if all expenditures for the pur- 
pose of preventing accidental loss are to be regarded as 
insurance premiums, a very considerable part of the cost 
of production must come under that head. Such an exten- 
sion of the term, insurance, utterly destroys its economic 
significance. Nor is the situation much improved by limit- 
ing its application to the expenditures for those preventive 
measures that make it possible to obtain insurance from 
organized companies at a lower rate. The distinction does 
not depend on any such accidental circumstance as that. 
It goes back to the fundamental difference between the 

1 See, for example, Alfred Marshall, Principles of Economics, Vol. I, 
p. 469, note. "Again, certain insurance companies in America take 
risks against fire in factories at very much less than the ordinary 
rates, on condition that some prescribed precautions are taken, such 
as providing automatic sprinklers, and making the walls and floors 
solid. The expense incurred in these arrangements is really an insur- 
ance premium. ..." 



FUNCTION OF FIRE INSURANCE 113 

methods by which the amounts of the two kinds of pay- 
ments are determined. One includes an element of reward 
for risk-taking, which in the case of insurance goes to the 
insurer, whose capital is bearing the risk; the other is 
determined by the direct cost of introducing the preventive 
measure, whether the work is done by the entrepreneur 
himself or by the company. Prevention and insurance 
are complementary methods of preparing to meet uncer- 
tain losses; only confusion can result from the attempt 
to make them identical. 

Not only do insurance companies carry on many forms 
of activity that are no part of their peculiar functions as 
insurers, but not all their activity as insurers has any 
direct bearing on the productivity of capital. The insur- 
ance of consumption goods is almost as common as the 
insurance of capital goods. It would not be difficult, in 
the light of the principles already discussed, to discover 
the laws that determine the adoption of insurance by the 
owners of consumption goods, or the nature of the social 
service that such insurance renders. A study of that 
sort would not be without interest, but it is outside the 
range of our investigation. We are concerned only with 
the insurance of capital, that is, with insurance as a method 
of lowering the cost of producing commodities. 

Insurance is primarily a method of making accumula- 
tions to meet uncertain losses. Attention has already 
been called to the gain that accrues to society through 
the reduction in the amount of such accumulations which 
insurance brings about. There are one or two other 
points in connection with this aspect of the institution 
that deserve consideration. Capital alone can insure 
capital. The guarantee of security by one who had no 
means of making good the losses that occurred would be 
a fruitless proceeding. The amount of capital necessary 
to give security evidently depends on the amount of risk 
that the capital assumes. As the number of risks carried 
by an insurance company increases, the amount of its 



114 YALE READINGS IN INSURANCE 

accumulations also must increase. Stock companies start 
with a certain amount of capital contributed by the mem- 
bers of the company, and make additional accumulations 
out of the contributions of the insured. Mutual com- 
panies, if they are to perform their functions perfectly, 
must also make accumulations of the same kind, but these 
funds are all contributed by the insured themselves, who 
virtually constitute the company. From the point of 
view of economic theory the difference between the two 
kinds of companies is of no significance. One form of 
insurance is not necessarily any cheaper than the other. 
If the entire business of insurance were on a strictly com- 
petitive basis, and if the accumulation of the companies 
were in all cases limited to the amounts necessary to give 
security, it would be a matter of no importance by whom 
the funds were contributed. Capital is invested in the 
business of insurance for the same purpose that any other 
investment is made — in order to obtain reward. If the 
insuring fund of the mutual companies is made up out of 
the current contributions of the insured, the owners of 
the capital thus invested will require in some form the 
same return on their capital that they could obtain in 
any other investment with the same degree of risk. The 
members of the mutual company are carrying on the busi- 
ness of insurance with a part of their capital, which acts 
as a guarantee fund for the capital that they have invested 
in more hazardous enterprises. The gain accrues to the 
insured as insurers instead of accruing to the members of 
a stock company. As there is no reason why the accumu- 
lations of mutual companies should be any less than the 
accumulations of stock companies, of which the capital 
stock forms a part, there is no reason why the return to the 
capital thus invested should be any less in the former than 
in the latter. Whatever gain can be secured under com- 
petitive conditions by insuring in a mutual company rather 
than in a stock company is due to the fact that the insured 
themselves have invested capital in the insurance business. 



FUNCTION OF FIRE INSURANCE 115 

How large the accumulations of insurance companies 
ought to be in proportion to the risks they carry can be 
determined only by experience. The prime requisite of 
such an institution is security. Therefore the accumula- 
tions must be large enough to cover the probable losses, 
with a margin of safety for unexpectedly large ones. It 
is safe to say, however, that the accumulations of many 
companies are in excess of the amount thus determined. 
I do not refer here to the accumulations made by life insur- 
ance companies, which combine entirely different functions 
with that of insurance, and a large part of whose funds 
represent simply investments of capital by the insured. 
Nor do I include that part of the funds of insurance com- 
panies which is used for other purposes than insurance, 
such as the expenditures for preventive measures. That 
part of their accumulations which is strictly an insurance 
fund is often larger than it needs to be. The possibility 
of making such unnecessarily large accumulations is due 
to imperfect competition, which does not force the cost of 
insurance down to the competitive level. If, however, 
it were necessary for these funds to lie idle in the vaults 
of the company, it is evident that there would be no motive 
for making accumulations larger than the conditions of 
the business demanded. Any excess would be distributed 
as dividends among the stockholders of the company, or, 
in a mutual company, would result in an immediate lower- 
ing of the insurance premium. That this distribution of 
the entire surplus does not take place is explained by the 
fact that capital which is insuring the other capital is not 
prevented on that ground from participating in other 
forms of industrial activity. We have already seen in 
the case of the capitalist-entrepreneur that while his own 
capital acts as a guarantee fund for the capital that 
he borrows, it at the same time performs its part in the 
direct productive activity of the industry in which it is 
invested. The fulfilment of the insurance contract does 
not require the creation of new capital; it requires merely 



116 YALE READINGS IN INSURANCE 

the transfer of the ownership of existing capital. There- 
fore the accumulated funds of insurance companies, even 
that part of them which is economically necessary, instead 
of remaining otherwise unproductive, are invested in such 
ways that they earn an income for the company. Of course 
there are certain restrictions as to the forms in which 
such investments should be made. For practical reasons 
it is desirable that the funds should be invested where there 
is the least danger of loss, and where the difficulty of realiz- 
ing on the investments is at a minimum. But the im- 
portant point is that capital which is insuring other capital 
may at the same time be directly employed in the pro- 
duction of wealth. The unnecessarily large surpluses of 
insurance companies are allowed to accumulate, not for 
the sake of the reward they can obtain in the insurance 
business, but for the sake of the interest paid for their 
use by those to whom they are lent. 

It is evident that the possibility of using productively 
the reserve funds of insurance companies reduces the cost 
of insurance. Under competitive conditions the return 
that capital invested in the insurance business can secure 
will be fixed. In the long run it will consist of pure inter- 
est plus the reward for carrying the risk to which it is 
exposed. All other income that the companies receive 
will operate to reduce the payments of the insured. If it 
were necessary for reserve funds to remain unproductive, 
the income that they now earn would have to be obtained 
from the insured in the form of higher premiums. 

One question in this connection remains to be answered: 
In what sense is the employment of capital to insure other 
capital a productive function? The difficulty in answering 
this question is due to two circumstances. On the one 
hand, capital which is insuring other capital may at the 
same time be productively employed in other ways and 
create the same amount of physical product as any other 
capital so employed. On the other hand, the reward 
which capital obtains for insuring other capital is entirely 



FUNCTION OF FIRE INSURANCE 117 

created by the capital that is insured. It is evident, 
therefore, that insuring capital, as such, is not directly 
creating physical product. Its service is to create a con- 
dition which increases the productivity of the capital that 
is insured. In return for this service a part of the product 
of the insured capital is handed over to the insurer. But 
this is not to deny the productivity of the insuring capital. 
In an economic sense the product of a unit of capital is 
the part of the total product whose creation is due to the 
presence of that particular unit. If, then, the insuring 
capital, by virtue of its service in guaranteeing safety, 
increases the total product of the insured capital, the 
additional part must be attributed to the insuring capital 
as its product. If there were a monopoly of the privilege 
of granting insurance, the entire increase in product might 
be appropriated by the insurers. Perfect competition, on 
the other hand, would bring about an influx of capital 
into the insuring business which in the end would reduce 
the total return to capital in it to the same proportions 
as the return to capital in any other industry involving 
the same degree of risk. The remainder of the economic 
gain due to the existence of the institution of insurance 
would then accrue chiefly to the consumers of the commodi- 
ties created in the industries in which the insured capital 
is employed. There is no fundamental difference in kind 
between the reward for risk-taking which accrues to capital 
employed directly in a hazardous enterprise and the reward 
which insuring capital obtains for the risk it assumes. In 
both cases there is an increased productivity of industry 
on account of the assumption of the risk, and in both cases 
the capital exposed to risk obtains a part of the increased 
product as its special reward. In both cases, moreover, 
the amount of the extra reward which capital can obtain 
by assuming risk is fixed by the sacrifice of the most reluc- 
tant investor whose capital is needed to meet the demands 
of society. The only difference between the two kinds of 
income is the comparatively unimportant one that in the 



118 YALE READINGS IN INSURANCE 

former case the extra product is created directly by the 
capital that receives it, while in the latter case it is created 
by other capital and handed over to the insuring capital as 
a reward for creating the conditions which make possible 
the increased productivity of the capital which is insured. 

The statement is sometimes made that all insurance is 
mutual insurance. 1 It is evident from a consideration of 
the facts already established that this is only partially 
true. All insurance is mutual in the sense that all the 
losses are in the long run paid by the insured. Obviously 
an insurance company could not long survive if it syste- 
matically made good the losses of the insured out of its 
own capital. To the company the payment of losses is 
an element in the cost of carrying on its business, and in 
the long run consumers necessarily pay all the expenses 
of production. This mutual aspect of insurance, how- 
ever, does not bring out its fundamental significance. This 
lies in the reduction of the cost of producing commodities 
through the relief of producers from the disagreeable 
feelings aroused by uncertainty, and the substitution of 
security for insecurity. The burden of insecurity, which 
would rest upon individual producers in the absence of a 
system of insurance is in no way borne by the insured as 
a body after insurance has been introduced. A large part 
of it is entirely annihilated, and the remainder rests upon 
the insurers whose capital has assumed the risks of the 
insured. Even in the case of so-called mutual companies, 
while the surviving uncertainty is still borne by the mem- 
bers of the company, the real significance of the institu- 
tion does not lie in this fact, but in the reduction of the 
uncertainty as a result of the insurance. The over- 
emphasis of its importance in causing a diffusion of loss 
is due to an imperfect analysis of its economic effects. 

Insurance is evidently far from being a gratuitous gift 

1 See, for example, H. C. Emery, "The Place of the Speculator in 
the Theory of Distribution," Publications of the American Economic 
Association, 3d Series, Vol. I, No. 1, p. 105. (1900). 



FUNCTION OF FIRE INSURANCE 119 

to society. The component parts of its cost are the wages 
of the labor employed in the insurance business, interest 
on the capital invested in it, and any increase in the amount 
of positive loss through fraud or carelessness, which the 
existence of insurance induces. This cost first falls upon 
the entrepreneurs who choose to insure their capital rather 
than to pay capitalists a higher price on account of risk. 
To the entrepreneurs, therefore, it is a part of the cost of 
production; it will be embodied in the price of the com- 
modities, and will thus be shifted to the shoulders of con- 
sumers. It is in the end the consuming public that pays 
the entire expense of insurance. This does not by any 
means imply that the condition of consumers is not bene- 
fited by the existence of insurance. The comparison lies, 
not between the cost of insurance and no cost, but between 
the cost of insurance and the cost of risk without insur- 
ance. The gain to the consumer comes through the re- 
duction in the price of commodities, and the amount of 
the reduction is determined by the difference between the 
interest which the entrepreneur would have to pay for 
capital exposed to the entire risk of the industry on the 
one hand, and the lower interest on the capital when it 
is insured, plus the cost of the insurance itself on the other 
hand. 

There has been a singular lack of unanimity among 
writers on political economy with regard to the division 
of economic theory in which the treatment of insurance 
ought to be placed. Some have considered it in connec- 
tion with production, others have' regarded it as a phe- 
nomenon of consumption, while still others have found it 
inexpedient to bring it under any of the recognized divi- 
sions, and have put it at the end of their works along with 
other subjects of a more or less dubious economic character. 
There seems to be little occasion for such uncertainty. 
If the old divisions of production, distribution, exchange, 
and consumption are to be maintained, there is no doubt 
that the proper place for the discussion of insurance, at 



120 YALE READINGS IN INSURANCE 

least so far as insurance of capital is concerned, is in the 
department of production. With regard to the insurance 
of consumption goods the case may not seem so plain at 
first sight, since there is not the same direct relation 
between such insurance and the productivity of industry. 
Nevertheless, it undoubtedly belongs in the division of 
production. It belongs there, not because it affects the 
productivity of other capital, but because the creation of 
security is in itself a form of production. If the owners 
of consumption goods are willing to pay a price for the 
sake of having them insured, it is evident that they are 
obtaining something in exchange which is of more value 
to them than the money with which they part. What 
they obtain is security, and whether or not it seems best 
to consider such security as a consumption good, or as 
any form of wealth, it cannot be questioned that the capi- 
tal and labor engaged in creating it are serving mankind 
in the same way as that employed in the creation of any 
commodity for which consumers are willing to pay. 

The conclusions reached in the present chapter are in 
part as follows: Complete insurance, in the economic 
sense, is the accumulation of funds for uncertain losses, 
and the combination of the risks of individuals in a group. 
The advantage of such an institution in society is the result 
of its influence in reducing the burden of risk. To call all 
insurance mutual, or to define it as the distribution of 
losses, is to put the emphasis on a comparatively unim- 
portant aspect of it; to call it gambling is to confuse forms 
of activity fundamentally different both in their purpose 
and in their consequences. Capital employed in insuring 
other capital is productive, and the reward it receives is a 
part of its product. Capital employed in insuring con- 
sumption goods is creating something for which the owners 
of the goods are willing to pay. It, therefore, is also pro- 
ductive. The treatment of insurance naturally belongs 
in the division of economic theory that deals with the 
phenomena of the production of wealth. 



CHAPTER VI 

ORGANIZATION OF COMPANIES * 

In a general way it may be said that fire insurance is 
transacted through three different agencies, the first and 
most important of which is the stock companies; the second, 
the various forms of mutual companies, and the com- 
paratively unimportant third, the association of individ- 
ual insurers known as individual underwriters, and Lloyds. 
Mutual companies again may be divided into three classes 
— first, the local county or town mutuals; second, the state 
or general mutuals, and third, the manufacturers mutuals 
commonly known as the factory mutuals and their imi- 
tators. 

The local or county mutuals are by far the most numer- 
ous of any class of companies in the United States. Their 
number is approximately 1500. There are 125 in New 
York State alone. 

The laws which govern their organization and operation 
are very dissimilar in the different states. In some 
states, notably in New York, they are prohibited from 
operating in large cities. This is, in New York at least, a 
result of the great fire of 1845, when all existing mutual 
companies doing business in New York City were bank- 
rupted. Usually their operations are limited by law to a 
few non-hazardous classes — such as farm property, 
dwellings, churches, and stores — in a given limited dis- 
trict. Often their operations are comfined to a town or 

1 By Richard M. Bissell. Lecture at Yale University, January 25, 
1904. Reprinted from pages 66-85 of the "Yale Lectures on Insur- 
ance, Fire and Miscellaneous,' ' 1904. 

121 



122 YALE READINGS IN INSURANCE 

county, though in New York State a local mutual company 
may operate throughout five counties. 

As a rule they must have, before organization is per- 
fected, applications, i.e., promises for a certain amount 
of insurance, usually somewhere between $50,000 and 
$200,000, already on file, and a portion of the premiums 
therefor — commonly 25 per cent. — paid in advance in 
cash. 

Having secured the necessary applications, those who 
are organizing the company — usually a group of farmers, 
who think the charges of the stock companies are exorbi- 
tant — secure from the state authorities the proper papers 
of incorporation; then a meeting of the applicants or 
members is called and officers are elected. Business is 
then begun by issuing their policies to the original appli- 
cants. In most cases all the work of the company is done 
by the secretary, who very likely is the village postmaster, 
store-keeper, or bank cashier, and who receives a fee for 
each policy issued, or who may be compensated by a 
salary. Those interested in the company urge their 
friends and neighbors to join them, appreciating the neces- 
sity for a considerable number of policy-holders amongst 
whom the losses may be divided. The applications thus 
secured are usually passed upon as to valuations, desira- 
bility, etc., by the executive committee or board of direc- 
tors. If an application is approved a policy is issued by 
the secretary, and perhaps signed by one or two of the 
committee. These policies are issued in consideration of 
a small cash payment, equal to about one-fourth the 
price commonly charged by stock companies, and a note 
given by the applicant for an amount equal to three or 
four times the cash payment. These notes are subject to 
call if the needs of the company so require. Each policy- 
holder is liable for the losses of the company, according 
to the articles of agreement or incorporation or the by-laws 
of the particular company in which he is insured, or per- 
haps according to an agreement assented to when the 



ORGANIZATION OF COMPANIES 123 

policy is issued. Sometimes the limit of liability is stated 
in the policy. In some cases each policy-holder is liable 
for his fractional share of any or all liabilities which may 
come to the company. More often, however, this lia- 
bility is limited to a certain percentage of the amount of 
insurance the individual carries or to some multiple of the 
amount for which he has given premium notes. The 
policies are usually issued for five years. 

Since the executive committee and all the applicants are 
neighbors and acquaintances, the personal and financial 
qualifications of every applicant, as well as the value and 
condition of his property, are well known, and thus the 
danger from dishonest losses or over-valuation is reduced 
to a minimum. No man with a bad reputation can secure 
insurance in one of these institutions, if it is properly 
conducted. Moreover, every policy-holder is constantly, 
as it were, under the surveillance of his neighbors, who are 
members — many of them — of the same company; con- 
sequently the opportunities for the successful perpetration 
of fraud are not good. Furthermore, while in many rural 
communities it is considered a very clever business stroke 
to get the better of one of the large stock companies, who, 
like the railroads, are looked upon as natural enemies, 
it is an entirely different matter when a man's desire to 
realize on his policy results in an assessment upon his 
neighbor. An attempt to do so, whether successful or 
not, usually results in ostracism for the offender. 

These companies, when wisely and honestly managed, 
succeed or fail according to the burning record of the dis- 
tricts where they operate. A few heavy losses in the 
earlier years of their existence usually finish them. 
Farmers and villagers quickly tire of assessments. On 
the other hand, in those districts which have had favor- 
able records as to fires — and there are many such — 
these little companies live and prosper for years. Often 
they accumulate assets of considerable value and in such 
cases furnish indemnity to their members at very low cost. 



124 YALE READINGS IN INSURANCE 

Having no expense of any kind save the fees of the secre- 
tary and the cost of their few supplies, they can be very 
economically operated. Whether their record as a whole 
has been one of profit or loss to their members cannot be 
said with any degree of certainty. Large numbers are 
organized and equally large numbers fail every year, and 
while many are short-lived, some exist to-day which are 
fifty or more years old. Their strength and their weak- 
ness alike are largely due to the fact that they transact 
business in a very limited field, where every risk is known 
and watched, but where a few losses make insurance very 
costly owing to the limited number of those among whom 
the losses are distributed. They are usually free from 
the heavy burden of taxation which rests upon stock 
companies, being thus favored by that policy of dis- 
crimination on the part of the legislator which so often is 
in evidence where the farmer or laboring man is concerned. 
Concerning the formation of the mutual companies 
which dp a general business throughout one or more 
states, and which are usually called state mutuals to dis- 
tinguish them from county and town mutuals, the laws 
of the different states vary to an extreme degree. In 
New York and some other states there are no laws what- 
ever governing or controlling such companies. In others, 
as for instance Wisconsin, the laws are specific and minute. 
On the whole, the most marked difference between these 
laws and those which govern the town mutuals concern 
the amount of applications for insurance which must be 
secured before a charter can be had. In Wisconsin this 
amount is $750,000 as compared with $50,000 for a local 
mutual company. In some states the classes of business 
which these state mutuals may write are limited by law; 
in others the maximum amount of liability which may be 
assumed on any one risk is so fixed. The Wisconsin law is 
remarkable for providing specifically for five kinds of 
mutual companies which may transact business over an 
extended territory. Among them are companies formed 



ORGANIZATION OF COMPANIES 125 

by retail lumber dealers, hardware dealers, church societies, 
and finally a class unique in insurance history so far as I 
know, viz., mutual companies formed by the treasurers 
of county insane asylums and poor houses. 

These general or state mutuals have not on the whole 
been successful, for, having ordinarily no great strength 
of assets, they cannot command business in districts 
remote from their place of domicile, except by quoting 
dangerously low prices. Moreover, they are compelled 
to delegate to agents or others the power to select risks 
and do not always get the best service. Those who 
operate the company lack the incentive of profit, a most 
important factor. 

Such companies commonly do not possess and cannot 
acquire the highly trained staff, the complete organization 
and concentration of authority necessary for the success- 
ful prosecution of a general business under competitive 
conditions throughout a wide territory, and when such 
powers are given to some official of a mutual company, too 
often the trust is abused. As long as the business grows 
rapidly and heavy assessments are avoided — for the loss 
ratio on a rapidly growing business is always small — the 
members are not likely to interest themselves in the 
methods pursued, and when, after a time, the assessments 
become heavy it is usually too late to apply a remedy. 
The fact that there were seventy-four such mutual com- 
panies in New York State alone in 1853, and but two or 
three to-day, is sufficient commentary on their experience, 
to which it is perhaps permissible to add the following 
from the first annual report of the Insurance Department 
of the State of Pennsylvania, issued in 1863 : 

"Not a few mutual companies have been shipwrecked 
because of the ambition of officers to accumulate a large 
business; going far from home; trusting to agents, and 
measuring prosperity by the amount at risk and gross 
cash receipts. 

"Near home, within the limits of half a dozen counties, 



126 YALE READINGS IN INSURANCE 

the officers and members are more or less intimately 
acquainted with the character of those composing the 
partnership and the property at risk; but far from home, 
in this or other states, they are necessarily, to a great 
degree, ignorant. There the agent acts for them. His 
interest is to do as much business as possible and he is 
not always so critical as to the risks he assumes as he 
ought to be. In time, loss after loss is followed by assess- 
ment upon assessment, until the home members of the 
company find that the insurance which ought to have been 
cheap has turned out very dear. The cause of the disaster 
is very plain. The laws essential to cheap insurance have 
been set at defiance. Hazardous and special risks have 
been written at rates far less than the stock companies 
could afford, as if the mutual system contained within 
itself an exemption from the inevitable laws of hazard. 
The officers of the company attribute their misfortunes 
to an unprecedented run of ill luck. Mere chance played 
the smallest part in producing the catastrophe; want of 
knowledge and judgment the largest. Then comes the 
trouble. The policy-holders rebel against the payment 
of the large assessments. The company resorts to litiga- 
tion to compel payment. It is pressed to pay losses and 
is compelled, in turn, to press the payment of assessments. 
The practical usefulness of the company is at an end and 
its career is terminated amid the execrations of all parties 
interested." 

It is true that there are throughout the country a num- 
ber of fortunately prosperous old institutions of this kind 
which have been conservatively managed, have transacted 
a selected business only of the non-hazardous classes, and 
have confined their operations almost invariably to 
limited territory. These institutions have had honorable 
careers, and have furnished cheap indemnity. 

In life insurance the policy-holder looks to the company 
for a certain definite payment at some time in the future, 
and, so far as experience shows, runs little if any risk of 



ORGANIZATION OF COMPANIES 127 

personal liability by becoming a member of a mutual 
company. In fire insurance, however, the policy-holder 
contracts for indemnity against an extraordinary and 
even unlikely loss, and yet by joining a mutual company 
he exposes himself to the possibility of a serious personal 
liability, in the event of a conflagration, or if the bad 
selection of risks results in heavy losses. Instances have 
occurred where former policy-holders have been assessed 
as late as five years after their own policies had expired, 
and long after they supposed their connection with the 
mutual company of which they had been members had 
ceased. 

We now come to the consideration of the most interest- 
ing, and, so far as their influence on the methods of fire 
insurance companies and on the fire loss of the country 
is concerned, by far the most important class of mutual 
companies, viz., those known as the factory mutuals. 

Edward Atkinson, LL.D., one of their most eminent 
officials and advocates, is authority for the statement that 
this class of companies was devised for the "prevention of 
loss by fire, the payment of indemnity for losses sustained 
being a secondary matter. 

Theoretically speaking, insurance companies pure and 
simple have nothing to do with the prevention or extin- 
guishment of fires, or with the reduction of the fire waste. 
Their province is merely to distribute the losses which fires 
cause. Despite this truth, it was a short-sighted business 
policy which prevented the stock companies from actively 
cooperating with factory owners, especially with cotton 
and woolen manufacturers, who, when the burning ratio, 
and hence the cost of indemnity, had risen to an unbear- 
able extent, sought so to improve their property as to 
reduce the number and amount of losses and so indirectly 
the cost of insurance. It seems to be true, however, that 
the failure or absence of such cooperation was largely 
responsible for the origin of this class of factory mutual 
companies, whose methods as first practised by themselves, 



128 YALE READINGS IN INSURANCE 

later by the stock companies, have fairly revolutionized 
methods of protection against fire and made possible 
greatly reduced rates for risks of all classes when properly 
protected. 

The first of these companies was organized in 1835 by 
Zachariah Allen in Providence, Rhode Island, and was 
called the Providence Manufacturers' Mutual Company. 
In 1850 there were three of these companies, and the 
number had increased to seven by 1860. There are now in 
Rhode Island and Massachusetts eighteen such companies 
in active operation, and others in Pennsylvania and other 
parts of the country. These companies are carrying 
insurance amounting to over one billion of dollars on fac- 
tory property. 

The activity of these companies was greatly increased, 
and the expansion of their operations greatly aided, by 
the material advances in rates which were made by the 
surviving stock companies after the Chicago and Boston 
conflagrations. These advances, amounting to 56 per 
cent, or more, compelled factory owners to look about for 
less costly sources of indemnity, with the result that many 
of them adopted factory mutual methods of protection 
and secured the low-cost insurance resulting therefrom. 

From the outset these companies have endeavored, first, 
to ascertain and eliminate the causes of fires, and, second, 
to provide such ample protection that any fire which might 
occur should be extinguished with but slight loss. 

In these particulars the record of the Associated 
New England Factory Mutual Companies has been quite 
wonderful. Their method is to charge a cash premium 
based upon the class of work done, construction of the 
building in question, the extent to which dangerous 
processes are eliminated, and the extent and efficiency 
of the apparatus for extinguishing fires. No factory can 
secure the protection of this system unless in respect to 
all these matters it comes up to a prescribed standard of 
excellence. In addition to this cash payment, a liability 



ORGANIZATION OF COMPANIES 129 

for assessments equal to five times the cash premium is 
assumed by the policy-holder. As a matter of fact, how- 
ever, since 1850 no assessment has been found necessary 
by any of the New England companies. On the other 
hand, the cash premiums have not only paid losses and 
expenses, but have enabled a division of profits to be made 
at the close of each year. In this way the actual cost of 
indemnity is reduced to a small amount. 

Mr. Atkinson ascribes the success of these companies to 
recognition of the following principle: "The only persons 
who can prevent loss by fire are the owners or occupants 
of the insured premises. Upon them rests the responsi- 
bility for heavy loss, if any occurs, in nearly every fire. 
All that the insurance company can do is to pay indemnity 
for loss which, if large, in nine cases out of ten, is due to 
the lack of apparatus for preventing loss or to the lack of 
care and order in the conduct of the work." 

In their efforts to ascertain and eliminate the causes of 
fire, these companies have investigated and endeavored to 
safeguard all processes used in manufacture. They have 
investigated methods of illuminating, heating, lubricating; 
have devised elaborate plans for the safe construction and 
arrangement of factories in order that the spread of fire 
might be retarded and that especially dangerous processes 
might be isolated, and, finally, have tested and applied 
the most modern and approved apparatus for extinguish- 
ing fires. Moreover, when a factory comes into their 
membership they not only see to it that in all respects its 
condition is brought up to their requirements, but by 
frequent inspection they secure the constant maintenance 
of such conditions. They are, indeed, hardly to be called 
insurance companies at all, but rather associations of 
manufacturers with experienced inspectors and engineers, 
whose work it is to eliminate the possibility of loss or 
serious damage by fire. The insurance feature only 
comes into play when, despite their precautions, a damage 
is incurred. It will be realized that, though the number 



130 YALE READINGS IN INSURANCE 

of fires and the loss resulting therefrom have been very 
greatly reduced by these methods, a large expenditure 
is necessary to construct, arrange, and equip a factory 
in such a way as to bring it up to the standard of their 
requirements. 

While to these factory mutuals must be given the chief 
credit for inaugurating such plans for safeguarding prop- 
erty, the stock companies have for a number of years been 
pursuing methods of cooperation with the owners of 
factories, and other classes of property as well, similar to 
those briefly hinted at above, and now are as well equipped 
as the factory mutual companies to make suggestions to 
property owners for the proper construction, arrangement, 
care, and protection of their property. 

The properties thus equipped in accordance with the 
views of experts are called " protected" or " equipped" 
risks, and there exists the keenest rivalry between the 
factory mutual companies and the stock companies to 
secure the control of this class of business. Thus far the 
efforts of the mutual companies have been more success- 
ful, especially in New England, though the stock companies 
are gradually reducing their rates to a point where they 
approximate the low cost at which the factory mutuals 
have been able to furnish indemnity. 

There is no reason why this class of mutual companies 
should not combine to prosper if they continue to confine 
their field to isolated and thoroughly protected factories, 
the hazards of which have been properly provided for. 

Mr. Atkinson, in regard to this matter, says, "The method 
of granting contracts by the factory mutual companies 
must of necessity be limited to special establishments, 
each carefully guarded from the other and fitted with its 
own apparatus for the extinction of fire. The mutual 
contract cannot safely be adopted in the crowded districts 
of large cities for the reason that the owner or occupant 
of one building may have a very dangerous neighbor in 
the next, over which he has no control." 



ORGANIZATION OF COMPANIES 131 

There are two factors unfavorable to this class of com- 
panies; first, the possibility that too extensive liability, 
as compared with the income, may be assumed on individ- 
ual risks, owing to implicit reliance on the experience 
already gained, in which case dangerously large losses 
may be incurred; and, second, the growing competition 
of the stock companies for the protected risks, which is 
constantly becoming keener. The stock companies have 
two important advantages to offer their patrons; first, 
that their policies are issued at net cost instead of in con- 
sideration of a cash payment to be later reduced by 
dividends; second, that no liability whatever is assumed 
by the policy-holder. 

Insurance organizations of another class have flourished 
in great numbers during the past ten or fifteen years. 
These are known for the most part as Lloyds of one kind 
or another. They are voluntary partnerships for the 
purpose, of insuring property. As a rule each partner is 
liable for a certain portion of every loss which occurs. 
The name Lloyds is, of course, taken from the famous 
English institution, and is too often used in order to 
convey the impression that these new American concerns 
are comparable in point of resources and reliability with 
that office. As a matter of fact very few indeed of the 
so-called Lloyds in this country are in a position to offer 
reliable contracts of indemnity. They furnish the com- 
bined promises of a number of private individuals, and 
the value of the contract in most cases is entirely dependent 
upon the financial strength of these individuals, though in 
a few instances a guarantee fund is paid in, which is liable 
for claims. Some of these concerns are responsible and 
have honestly and promptly paid their losses. Most of 
them, however, are without any of the qualities which a 
company transacting an insurance business should possess, 
and not a few are operated solely in order to get possession 
of premiums, which are not by any means designed to be 
accumulated for the benefit of their foolish patrons. One 



132 YALE READINGS IN INSURANCE 

very frequent feature of their contracts, which makes 
them without particular value in the congested sections 
of large cities, is the provision that in case of a general 
conflagration the liability of each partner under all out- 
standing contracts shall be limited to a certain fixed 
amount. These policies are usually issued through some 
one agent acting for all the partners, who, as a rule, know 
nothing about the transactions in which their names and 
credit are involved. 

While these Lloyds are most of them new institutions — 
recent phenomena in the insurance world — their opera- 
tions have been so general and the results so unsatisfactory 
to the public, that in ten states laws have been passed 
which require a cash deposit or capital to be paid in by 
every such partnership as security for the fulfilment of 
their contracts. One state — Pennsylvania — prohibits 
them altogether. In seventeen states there are as yet no 
laws applicable to them. In the rest of the United States 
they are, by the wording of the insurance laws, subject 
to the same restrictions and requirements as ordinary 
insurance companies. There are from sixty to seventy 
of these Lloyds now in existence operating in a more or 
less general way in the United States, of which number 
perhaps less than half a dozen are responsible and worthy 
of a limited recognition. There is no way of ascertaining 
the volume of business which these institutions transact. 

We now come to the consideration of the methods of 
incorporated stock companies, which, as before stated, 
form altogether the most important class of insurance 
companies, both as to the business transacted and as 
to solidity of assets and reserve, and which transact 90 per 
cent, of all the business done in the United States. 

In the case of American companies, at least, it is usual 
for the directors to concern themselves chiefly with the 
financial or banking department of the company's busi- 
ness, largely because insuring property against fire is a 
business requiring technical training and one which must 



ORGANIZATION OF COMPANIES 133 

be conducted by men well versed in its numerous details. 
Therefore the business of insuring property is commonly 
left to the officers of the company and their assistants. 

The whole country is usually divided into districts or 
departments and an officer, or more than one, placed at the 
head of each. These departments in some cases are all 
under the immediate supervision of the chief executive 
and located in the head office of the company. It is 
believed by some company officers that a more consistent 
policy, a more uniform method of procedure and greater 
economy of operation can be secured in this way. The 
majority of companies, however, establish departments 
in various large cities, each department having jurisdiction 
over the states naturally tributary to the city where it is 
located. These departments are usually called general 
agencies. The companies which maintain them do so 
because of the belief that in this way they can get in 
closer touch with their various agents and with the insur- 
ing public, and therefore can secure the best obtainable 
results, both as to the amount of business obtained and 
in the matter of closely supervising it. The cities usually 
selected for department offices are New York, Chicago, 
and San Francisco, and, to a smaller extent, Boston, 
Philadelphia, Atlanta, New Orleans, and one or two others. 

The head office of the company contains the department 
for the states adjacent thereto. These departments are 
intended to work thoroughly the territory under their 
jurisdiction according to the general scheme of operations 
adopted by the company. Some companies endeavor to 
secure business from the larger cities only, but, both for 
the sake of a larger income and because of the safety and 
steadiness which can only be secured from a widely dis- 
tributed business, most companies endeavor to get busi- 
ness from all possible sources where a profit is likely. 

The business is secured by means of agents residing in 
the various towns and villages where the company operates. 
These are called local agents. In large cities, such as 



134 YALE READINGS IN INSURANCE 

Cleveland, Rochester, Louisville, etc., these local agents 
usually devote their entire time to securing and handling 
the business, and often the same man or firm in such a 
city will act as agent for anywhere from one to a dozen 
insurance companies. In the smaller places, however, 
the amount of business to be done is so small and the 
number of companies desiring it so large that the business 
usually demands only a portion of the agent's time, and 
is, therefore, combined with banking, the practice of law, 
store-keeping, or some other occupation. Moreover, the 
agent in such little places acts for as many companies as 
he will consent to represent. 

It will be seen that local agents are the means by which 
a company comes into direct contact with the insuring 
public. The local agents are the ones who secure for the 
company the business on which it feeds. They are, there- 
fore, a factor of supreme importance in the business, and 
companies endeavor through their special agents and in 
other ways to maintain cordial and friendly relations 
with them. In order to insure success, popularity with 
local agents is quite as important as popularity with the 
public in general. In order that there may be an intimate 
knowledge of the business at each agency, that new agen- 
cies may be secured and unsatisfactory ones discontinued, 
and to the end that all matters concerning the transactions 
between local agents and the department office may be 
properly supervised, men called special agents are em- 
ployed, whose duty it is to travel constantly over the field 
to which they are assigned, locating agencies at all avail- 
able points, carefully inspecting and securing accurate 
information concerning all the risks which the company 
insures, collecting overdue payments, endeavoring to 
secure from local agents as much desirable business as 
possible, and in general to further the interests of the 
company in every legitimate way. To them also is assigned 
for the most part the duty of arranging with claimants for 
the settlement and payment of the losses which occur in 



ORGANIZATION OF COMPANIES 135 

their particular territory, though some companies doing 
a very large business have so many losses to settle that 
expert adjusters, as they are called, are employed for this 
purpose only. The local agents are equipped by the com- 
pany with the various forms, books of record, and other 
supplies necessary for the transaction of business; also 
with blank, unsigned policies. 

When a contract is secured by an agent, from some 
property owner a policy is at once filled out, executed, and 
delivered to him, and as soon as possible thereafter an 
abstract of this contract, containing a full description of 
the property and all the details of the contract, is made 
out by the agent on a blank provided for that purpose, 
called a " daily report." This report is thereupon at 
once mailed to the department office which has jurisdic- 
tion over the territory in which the agent is located, and 
at the end of each month an account or statement of all 
the contracts made during the month is sent by the agent 
to the same department office, accompanied, or to be 
followed, by a remittance for the premiums collected. 

The local agent is compensated by a commission, usually 
15 per cent, on the amount of premiums secured or renewed 
by him. He is presumed and required to protect the 
interests of the company or companies he represents by 
carefully selecting desirable business and by following out 
their instructions in all matters. Companies endeavor 
to provide their agents with complete instructions as 
to their desires and methods concerning the conduct of 
business, so that agents may properly care for their in- 
terests. 

When the daily reports of policies issued reach the office 
of the company they are carefully examined and reviewed 
by trained men called examiners. If the wording of the 
contract (the form, so-called) is found to be faulty, if the 
price is deemed to be too low, or if any other error is dis- 
covered, the agent is promptly requested to amend the 
contract in the necessary particular. If the property 



136 YALE READINGS IN INSURANCE 

insured is deemed to be an undesirable subject for 
insurance he is requested to cancel or terminate the 
contract at once. 

The duties of the examiner are extremely important. 
They demand an intimate acquaintance with the hazards 
usually incident to various kinds of property; also famili- 
arity with the conditions affecting the district or town 
where each risk is located. Moreover, in judging a risk, 
the character of the ownership, the nature of the inherent 
and adjacent or exposing hazards due to the various 
occupants in the vicinity, the amount and quality of the 
protection against fire, the record of the locality as to 
fires, the rate, i.e., price obtained, and numerous other 
factors must be considered and investigated with con- 
siderable thoroughness by him. To facilitate this work 
the general offices are equipped with maps showing the 
construction and size of every building in the business 
districts of all towns of importance; also with commercial 
reports indicating the financial standing and business 
records of all merchants and manufacturers, inspection 
reports of important risks made by special agents and 
trained experts as well, and various other tables, books 
of reference and of rules, which aid the examiner in pass- 
ing judgment upon the numerous reports which come 
before him. A successful examiner, however, must have 
a clear head, quick perceptions, cool, careful judgment, 
and a very considerable knowledge acquired by experi- 
ence. The examiner has usually two or more assistants 
who help him in matters of detail. 

The monthly accounts or statements before referred to 
are also carefully gone over by auditors or bookkeepers. 
When the work of examining and auditing is done, the 
daily reports and the accounts pass on into the hands of 
a large force of clerks, who from them make up the elab- 
orate records and statistics which the insurance com- 
panies are required to keep, partly for their own guidance 
and partly to comply with the laws of the different states. 



ORGANIZATION OF COMPANIES 137 

In addition to the daily reports and accounts, canceled 
policies are also forwarded in large numbers by agents 
to the general offices; also notice of changes in contracts, 
called indorsements. Those must all pass through the 
same intricate and complicated process as the original 
daily report. 

In another part of the office the losses are handled. 
Every loss is at once reported to the general office in whose 
territory it occurred. It is then assigned to the proper 
man for settlement — usually a special agent. As soon 
as possible he visits the scene of loss and arranges a settle- 
ment with the property owner. The completed reports 
of these settlements are forwarded to the general office 
and are very carefully tabulated, classified, and compared 
with the record of premiums received, the premiums and 
losses of each class being grouped by themselves in order 
that the experience of the company, that is, the profit or 
loss arising from transactions with each class of risks, 
may be ascertained. A large department office in the 
course of one year will receive, perhaps, 125,000 daily 
reports from its agents, who will be located in, say, 2500 
cities, towns, and villages. These daily reports will carry 
premiums averaging about $20 each, or amounting to 
$2,500,000 in all. Such a department will also have to 
adjust and pay from 3000 to 4000 losses each year. To 
keep the elaborate records and tables of statistics concern- 
ing all these transactions, to watch them throughout the 
life of the contracts, to collect the moneys due and to 
pay carefully and justly the losses — all these tasks in- 
volve an amount of detailed, arduous, and technical labor 
which is formidable to contemplate. They also render 
necessary the services of well-trained men — high-priced, 
many of them — and a very large expenditure for proper 
equipment and maintenance. At the head of such a 
department is a manager, or general agent, as he may 
happen to be called. He is responsible for the results 
obtained in the territory under his jurisdiction. He must 



138 YALE READINGS IN INSURANCE 

see to it that the numerous and troublesome details of 
the general office work are kept up, exercise general 
supervision over the examiners and their work, direct the 
movements of the traveling special agents and inspectors, 
decide all important questions arising in loss settlements, 
and last, but not least, utilize all these various factors 
in such a way that the company may secure its fair pro- 
portion of desirable business. A large department as 
indicated above will have on its rolls from 2000 to 3000 
agents and perhaps one hundred or more salaried em- 
ployees. 

At the head of the company the president and other 
officers exercise a general oversight over all the depart- 
ments. Usually monthly tabulated reports of all trans- 
actions are made by the departments to the head office. 
Any profits are also remitted to the head office for invest- 
ment. On the other hand, if losses exceed the receipts of 
any department, advances are made to that department. 

The officers are also charged with the duty of deciding 
upon the general policy and methods of the company for 
the guidance of the various departments. The amounts 
for which liability may be assumed on different kinds of 
risks are also determined by them. In other words, the 
plan of campaign is laid out and managed by the officers 
and executed by the department managers through their 
special and local agents. In the case of those companies 
which do not make use of separate departments located 
in different parts of the country, a large staff of officers 
is customary at the head office, where the junior officers 
perform the duties usually devolving upon department 
managers. 

In the large cities where values are great and congested 
and where consequently the amount of business to be 
done is very large, another class composed of middlemen 
or brokers, as they are called, has arisen. These men 
secure from property owners orders for insurance which 
they then place with the local agent and in return receive 



ORGANIZATION OF COMPANIES 139 

a portion, usually one-half or more, of the agent's com- 
mission. These brokers usually take entire charge of the 
insurance affairs of their patrons, acting as their agents 
in all matters relative thereto. In New York City so 
universal is this method of transacting business that there 
are practically no local agents who solicit or secure busi- 
ness direct from property owners, and most companies 
maintain their own offices with salaried managers, with 
whom the brokers deal. 



CHAPTER VII 

ORGANIZATION AMONG THE COMPANIES 1 

The stock fire insurance companies, while they are 
in intense competition with each other, have found it 
desirable to do much of their work through organiza- 
tion among themselves. 

In point of territory covered the greatest of these 
is the National Board of Fire Underwriters. The 
membership of this embraces 124 of the leading com- 
panies. It has been in existence since 1866; in its 
early years it endeavored to fix both rates and com- 
missions for the whole of the United States, but this 
work proved impracticable and was abandoned. Its 
principal function to-day is educational, although to 
a certain extent it exerts a general influence toward 
uniformity and better practices in the business. It 
is the representative body which acts for the under- 
writers in matters of general importance to the com^ 
panies and the public. The National Board was 
represented, for instance, at the Joint Conservation 
Conference in Washington in 1908 and at the National 
Conservation Congress in St. Paul in 1910; at both 

1 From pages 28-34 of Report of the Joint Committee of the Senate 
and Assembly of the State of New York appointed to investigate 
Corrupt Practices in connection with Legislation, and the Affairs of 
Insurance Companies other than those doing Life Insurance Business. 
Assembly Document No. 30, February, 1911. 

Organization among companies is naturally more elaborate in New 
York than elsewhere; otherwise the description here given may be 
taken as fairly typical of inter-company organization in other states. 

W. H. P. 
140 



ORGANIZATION AMONG THE COMPANIES 141 

meetings the board presented through special com- 
mittees addresses on the subject of fire waste. 

The board, through a corps of engineers, carries on 
an extensive work in making surveys of the confla- 
gration hazard in cities. A report is issued on each 
city surveyed; this report is a basis for intelligent 
work in the betterment of conditions. 

The board, after an extensive study of the subject, 
has prepared a model building code; the adoption of 
this code is urged upon cities and the board is prepared 
to cooperate further by furnishing expert advice along 
these lines. 

The board prepares statistics of fire loss and the 
causes of fires. 

It is in close touch with the National Fire Protec- 
tion Association and the Underwriters' Laboratories 
and issues a great number of pamphlets, based on the 
work of these organizations as well as on the work of 
its own engineers, on the construction and installation 
of devices of a protective or hazardous nature; these 
pamphlets are given a wide circulation. 

It can be said that the work of the National Board 
is in the highest degree public-spirited and its activities 
are to be highly commended. 

The New York Board of Fire Underwriters is an 
incorporated body; its members are the managers 
and agents of companies doing business in New York 
City. It carries on somewhat the same kind of work 
as the National Board, but its field of operation is 
confined to New York City. 

It makes surveys of risks, promulgates standards 
of construction and equipment, and particularly of 
electrical equipment; it investigates important fires, 
it maintains a bureau of fire patrol, whose function 
is to protect and save property in case of fire; it 
maintains a bureau of adjustments which settles 
losses on which several companies are involved; it 



142 YALE READINGS IN INSURANCE 

interests itself in matters concerning water supply, 
the fire department, the fire alarm service, and the 
origin of fires. The board is represented by a delegate 
to the board of examiners of the building department. 

The New York Fire Insurance Exchange is an unin- 
corporated body; it was organized in 1899; it com- 
prises in its membership officers of local fire insurance 
companies and managers and head agents of out-of- 
town companies. Practically all the companies ad- 
mitted to this State which do business in New York 
City are represented in this body. 

The area of operation of the Exchange is the so- 
called metropolitan district, or substantially the pres- 
ent city of New York exclusive of its suburban or 
outlying portions; in other words, the borough of 
Manhattan, that part of the borough of the Bronx 
lying west of the Bronx river, the borough of Brooklyn, 
Long Island City in the borough of Queens, and the 
American Dock Stores and piers in the borough of 
Richmond. 

The object of the Exchange is the control of rates 
and commissions to agents and brokers; it fixes either 
specific or minimum premium rates on risks; it fixes 
the compensation of brokers and certain classes of 
agents. Certain branch office managers, so called, are 
allowed a commission of 12§ per cent, in addition to 
what they pay to brokers, and brokers are paid a 
commission of 5 to 25 per cent., graded according to 
location and class of property. The highest com- 
mission, 25 per cent., is paid upon the so-called " pre- 
ferred risks/' namely, dwellings and private stables, 
churches, schoolhouses, and combined store-and- 
dwellings. 

The Exchange issues certificates to brokers whom 
it approves and without this certificate it is impossible 
for a broker to do business with its members. The 
conditions upon which a certificate is granted are, first, 



ORGANIZATION AMONG THE COMPANIES 143 

that the broker must be engaged either exclusively 
in the insurance business or in real estate or closely 
allied employments; second; he must pledge himself 
not to make any rebate to or division of commissions 
with any assured or any person not a broker; third, 
he must pledge himself that he will not accept from 
any company or agent more than the commission 
allowed by the Exchange; fourth, he must pledge 
himself that he will not place risks with offices not 
members of the Exchange, unless sufficient insurance 
thereon cannot be obtained from Exchange members. 
The two pledges are given herewith: 

Brokers 7 Pledge, Class I. — In consideration of the 
commissions or brokerages at the current rate that 
may be fixed and established for the time being by, 
and to be paid by members of, the New York Fire 
Insurance Exchange, I hereby promise and agree that 
I will not, directly or indirectly, make any rebate to 
the assured nor directly or indirectly pay to or divide 
with any person not holding a broker's certificate, 
any commission or brokerage, nor will I receive from 
any company or agent, directly or indirectly, any 
remuneration for business placed with them in excess 
of that permitted by the rules of the Exchange. 

Brokers' Pledge, Class II. — In consideration of the 
payment to be made to me of an additional 5 per cent, 
to the commissions or brokerages as provided for in 
brokers' pledge, Class I, signed by me, I hereby promise 
and agree in addition to said pledge, that in placing 
insurance, I will give the preference to the members 
of the New York Fire Insurance Exchange, and that 
I will not place any risk with those not members 
unless I cannot secure sufficient insurance on such 
risks from members of the Exchange, in which case I 
agree to file with the secretary of the Exchange, within 
one week of so placing, a list of such outside company 
or companies in which same has been placed, with the 



144 YALE READINGS IN INSURANCE 

name of the assured, location of risk and the amount 
of insurance given them. 

About 7,500 brokers are at present certificated by 
the Exchange; the fee for the certificate is $10. About 
five-sixths of the buildings in the territory of the 
Exchange are given minimum, that is, non-schedule, 
rates according to the nature of the occupancy; these 
in general are the so-called " preferred risks." The 
remaining 50,000 buildings, comprising mercantile, 
manufacturing and other general hazards, are rated 
specifically, or by " schedule;" that is, the rate is 
built up for each building or stock by a detailed analysis 
of the hazard. 

An addition to the rate as otherwise determined 
may be made as a charge for local conditions, such 
for instance as bad streets or deficient water-supply, 
or an addition such as the "San Francisco Advance" 
made in 1906 in order that the companies might recoup 
themselves after the San Francisco conflagration. 

The Suburban Fire Insurance Exchange is an unin- 
corporated association of companies; its purpose is 
to control premium rates and commissions to agents 
and brokers. Its territory consists of Westchester 
county, Putnam county, Rockland county, Richmond 
county, the portion of the borough of the Bronx east 
of the Bronx river and all of Long Island outside the 
borough of Brooklyn. 

The Exchange was founded in 1907; prior to that, 
since 1900, there had been in this territory a period of 
open competition. The membership of the Exchange 
comprises about 140 companies; not all the companies 
writing in this territory are members of the Exchange. 

The Suburban Exchange is modeled on the New 
York Fire Insurance Exchange. The two pledges 
required of brokers are the same that are required by 
the New York Exchange. The Suburban Exchange 
allows all local agents a 20 per cent, commission; 



ORGANIZATION AMONG THE COMPANIES 145 

brokers who have signed the first pledge are allowed 
5 per cent, commission, and those who have signed 
both pledges are allowed 10 per cent, commission. 

About 145,000 risks, estimated to represent about 
75 per cent, of the premium income in suburban terri- 
tory, are rated under a system of minimum classifi- 
cation which in effect is a very simple form of schedule 
rating. The remaining risks, about 5,000 in number, 
in general are rated by schedule. 

The Underwriters' Association of New York State 
is an unincorporated association of the special agents, 
or fieldmen, of fire insurance companies; its head- 
quarters is Syracuse; its territory consists of all the 
counties north of Putnam and Westchester, except- 
ing the cities of Buffalo and Tonawanda. The asso- 
ciation has 124 members representing eighty-four 
companies; it was founded in 1884. 

The object of the association is the making and con- 
trol of premium rates, the promotion of cooperation 
among fieldmen and of good practices in the business. 

The local boards of underwriters, composed of local 
agents, are under the supervision of the State Associ- 
ation. The local agents of the companies that are 
represented in the association are forced to belong to 
these local boards and in joining they agree to main- 
tain the association rates. Most of the agents' daily 
report sheets pass through the hands of the associa- 
tion's stamping-clerks, who verify the correctness of 
the rate and see that the proper forms have been used. 
The association in this way is able to know whether 
or not the rates are being maintained. The same 
plan of local boards and stamping-clerks is followed 
by the Suburban Association. 

The rates of the State Association are largely made 
by schedule, although dwellings are for the most part 
on a tariff of minimum rates. The State Association 
does not concern itself with the subject of commissions. 



146 YALE READINGS IN INSURANCE 

The Buffalo Association of Fire Underwriters is an 
incorporated body composed of local agents of Buffalo 
and Tonawanda; its purpose is to make and maintain 
rates and to improve local practices in underwriting; 
it has about seventy members; most of the companies 
doing business in its territory are represented in the 
association. 

The agents' daily report sheets are reviewed by a 
stamping-clerk, for the purpose of correcting errors 
in rates and forms and detecting whether the rate has 
been observed. An agent who does not observe the 
tariff rate is disciplined. The rating is done largely 
by schedule. Brokers are certificated by the Buffalo 
Board and their rates of commissions are fixed. They 
are required to sign a pledge not to rebate and not to 
place risks with agents who are not members of the 
association or with brokers who do not hold certificates. 

The four organizations here named are the only 
rating bodies that operate in New York State. The 
important questions in the subject of rating and com- 
bination concern all four alike. 

It will be observed that there are some companies 
which do not belong to the rating organizations. 
These are called non-Board companies. The same 
company, however, may be a Board company in one 
part of the country and non-Board in another. In 
New York City only do the companies all belong to 
the Exchange. 

It is not necessary to name in detail the organiza- 
tions which make rates in the rest of the country, as 
they are in general similar to those already described. 
In certain states, however, notably the so-called " anti- 
compact " states where organizations of the companies 
for making or maintaining rates have been prohibited 
by law, the rating is done by a " rater" who has no 
connection with the companies; he makes so-called 
"advisory" rates and sells them to the companies. 



ORGANIZATION AMONG THE COMPANIES 147 

It has been seen that the New York Exchange and 
the Suburban Exchange regulate commissions to agents. 
In general, however, commissions are regulated by 
associations of companies formed for this special 
purpose; the eastern part of the country, from Maine 
to Texas, is under the jurisdiction of the Eastern 
Union; a similar organization called the Western 
Union has jurisdiction over the Middle West. 



CHAPTER VIII 



RATES AND HAZARDS 



In the language of fire insurance, the name "risk" is 
applied to any piece or kind of property which an insur- 
ance policy may cover. The hazards of a certain risk 
(as for instance a building), or of a certain class of risks 
(such as flour mills), are the peculiar or particular circum- 
stances or characteristics pertaining to or affecting it 
which favor or make for its destruction by fire. The 
extent to which these hazards endanger a given risk theo- 
retically governs its rate, i.e., the price, per cent., which 
must be paid for insurance. A brief examination of the 
subject of hazards, therefore, will naturally precede and 
lead up to the subject of rates. 

Hazards may be divided broadly into two classes, — 
physical and moral, or personal, as they are sometimes 
called. The physical hazards are inherent in the risk 
itself and in its surroundings. Moral hazards arise from 
personal factors. Physical hazards may be partially 
measured, appraised, estimated, and to a certain extent 
controlled. Moral hazards are hidden, presumed rather 
than known, not to be measured or scheduled. 

The causes of fires are of far greater variety than is 
commonly known. They are indeed almost infinite in 
number, for practically every substance and almost every 
process of labor, manufacture, or commerce is under cer- 

1 By Richard M. Bissell. Lecture at Yale University, February 8, 
1904. Reprinted from pages 92-126 of the "Yale Insurance Lec- 
tures, Fire and Miscellaneous," 1904. 

148 



RATES AND HAZARDS 149 

tain circumstances or in certain relations to other articles 
or processes productive of danger from fire. 

Physical hazards may be divided into two classes, as 
external and internal, which are sufficiently distinguished 
by their names. The external hazards include lightning, 
conflagrations, sparks, bonfires, forest and prairie fires 
(which are sometimes very serious hazards), and exposure, 
the greatest of which by far is exposure, — i.e., the danger 
to which a risk is subject from the burning of other risks 
or substances. To this cause is due 28 per cent, of all 
losses, both as to number and value. Property valued at 
$50,000,000 was destroyed by exposure fires in 1902. We 
speak of exposures as a hazard and attribute 28 per cent, 
of all losses to exposure, meaning thereby that as to 28 
per cent, of all risks that are destroyed or damaged, the 
losses are caused by fires the origin of which is exterior 
to the risks embraced in the 28 per cent. It is an obvious 
truth, however, that the original cause of an exposure loss 
is usually to be found in some physical hazard and, or- 
dinarily, an internal physical hazard pertaining to an ad- 
jacent risk. The following general rule may be laid down: 
The degree of exposure hazard to which any risk is subject 
is determined, first, by its own combustibility and igniti- 
bility, i.e., the readiness with which it will ignite and the 
rapidity and completeness with which it may be destroyed 
by fire; second, by the distance which separates it from 
the buildings or substances from which the exposure 
hazards arise; third, by the inherent hazards of the risks 
adjacent to it or within burning distance, and fourth, by 
the extent of protection which it receives from water works, 
fire department, or private apparatus. Under especially 
dangerous conditions there is hardly any limit to the burn- 
ing distance. In the summer of 1894, during a drought, 
accompanied by high winds, there were extensive forest 
fires in northern Wisconsin and Michigan, and risks were 
burned by exposure arising from fires twenty miles or 
more distant. Sparks and embers fell on the decks of 



150 YALE READINGS IN INSURANCE 

vessels many miles from land on Lake Superior. The ex- 
posure hazard constitutes a factor in the total of a risk's 
hazards, which is highly susceptible to reduction by effi- 
cient fire protection. In case of frame mercantile buildings, 
it frequently constitutes the most important factor in 
determining the rate. 

The most important of the external hazards are, in their 
order, — after exposure, sparks, which cause about 4 per 
cent, of the entire number of fires (locomotive sparks alone 
caused over 600 out of 1500 cotton fires during 1902, of 
which the average loss amounted to over $5000), and 
lightning, which is responsible for nearly 3 per cent, of all 
losses, or three and a half millions in 1902. 

The internal hazards are much more numerous and, 
leaving out exposure, much more productive of fires. They 
may be sub-divided into five classes, which, however, are 
not absolutely distinct. The first class, according to our 
arbitrary division, is spontaneous combustion. This, while 
ordinarily not an imminent hazard, becomes one whenever 
vegetable or animal fiber is handled or stored, as in cotton 
and woolen mills, cotton warehouses, ice houses, etc. It 
is a characteristic of these substances when more or less 
saturated with any oily substance (more especially if it 
be an animal oil or grease), that rapid oxidation or spon- 
taneous combustion ensues. Two hundred and three out 
of 1683 fires in cotton mills, and 151 out of 1630 fires in 
woolen mills, were due to this cause. 

The next general division comprises the hazards due to 
the operation of machinery. These include friction of 
machinery, heated bearings, accidents and breakages, 
overheated boilers and stacks adjacent to inflammable 
substances, and the presence of foreign substances in fast- 
running machinery. For example, in the pickers used in 
cotton and woolen mills and in cotton-ginning machines, 
sparks caused by the presence of stones, buttons, car- 
tridges, etc., caused a great many fires. In cotton mills, 
984 out of 1683 fires were caused by friction and the 



RATES AND HAZARDS 151 

presence of foreign substances in machinery, and in flour 
mills, 477 out of 2616 fires were caused by friction in 
machinery. 

The third division comprises the hazards incident to 
processes. Among these are hazards arising from dry 
kilns, roasting furnaces or ovens, use of inflammable mix- 
tures for painting or japanning, the compounding of com- 
bustible and explosive chemicals in drug and paint mills, 
the improper or careless handling of heated substances, 
such as molten metals or the dried fertilizer just from the 
dry kilns, the use of fire heat under kettles, etc., and the 
production of various explosive gases or mixtures, as, for 
instance, dust in flour mills and starch factories or benzine 
vapor in furniture factories or japanning ovens. 

The fourth and, so far as the number of losses and value 
of property are concerned, by far the most important of 
internal physical hazards is due to the various processes 
and kinds of apparatus used for purposes of heating and 
lighting. It is quite natural that the process of heating 
— which usually means the actual use of fire — should 
make more losses than any other cause, yet it is a sad com- 
mentary on American methods of building, and on Ameri- 
can laws concerning building, that defective flues should 
be responsible for twice as many fires as any other one 
physical or known moral hazard. This cause also is re- 
sponsible for a greater property loss than any other. Flues 
may be defective in construction, as when wooden joists 
or timbers are allowed to pierce their walls, or when un- 
protected holes are left by careless masons, through which 
sparks or flames may escape. They may become defec- 
tive by settling or cracking, due to insufficient support, 
or because the building is moved or shaken in consequence 
of a tornado or wind storm or if struck by lightning. In 
1902 over 14,000 fires, or 13 per cent, of the total number 
of fires, were attributed to defective flues, and the total 
property loss resulting was over $11,000,000. Other fires 
due to methods of heating were caused by hot ashes and 



152 YALE READINGS IN INSURANCE 

coals improperly deposited in dangerous places (barrels for 
example), or through carelessness or defective apparatus 
allowed to come in contact with combustible substances. 
Still other fires were caused by hot stoves and furnace pipes 
and by overheated stoves and furnaces, and the list in- 
cludes the fires caused by steam pipes passing through or 
adjoining unprotected wooden surfaces. In all, about 
20 per cent, of the total number of fires are directly trace- 
able to the use of fire for heating purposes. 

The fires due to methods of illumination included in 
1902 over 400 caused by candles, over 3700 from accidents 
to lamps, resulting in more than $2,000,000 of losses, 970 
from gas jets, and over 1000 from electric wires, which are 
classed with the methods of illumination for convenience, 
though electric wires are often used to convey power. The 
losses due to the use of electricity are larger by far in amount 
than those due to any of the other means of illuminating, 
chiefly, no doubt, because electricity is now so generally 
used in buildings and localities where large values are col- 
lected, while candles, lamps and even gas are now prin- 
cipally used in dwellings, small stores, and small factories; 
furthermore, fires of electrical origin are often not dis- 
covered until they have gained considerable headway. 
The value of property destroyed by fires of electrical origin 
in 1902 was $12,000,000. Fires due to other methods of 
illumination were more than four times as numerous as the 
fires of electrical origin, yet the ensuing loss was slightly 
below $5,000,000 or less than one-half the amount due to 
use of electricity. 

The fifth general division of internal hazards includes 
everything not already classified. The various fires due 
to accidents and carelessness find a place here. The list 
includes oil stove accidents, fires from matches, which 
caused in 1902, 4000 fires, with a loss of over one and a half 
millions of dollars, children playing with fire, cigars, ciga- 
rettes and tobacco pipes, with a record of 1100 fires in 
1902, and the numerous other causes of comparatively 



RATES AND HAZARDS 153 

smaller importance which have not already found men- 
tion. 

All of these classes and sub-classes of hazards might still 
be almost indefinitely re-subdivided, for new hazards and 
new manifestations of old hazards are to be met with daily. 
If the causes of the 76,000 fires which occurred in 1902 
could be ascertained with accuracy, each would be found 
to differ in some respects from every other. When all 
ascertainable hazards have been classified and the causes 
for fire set forth so far as we can ascertain them, there 
yet remains about 16 per cent, of all fires for which the 
causes cannot be discovered. It is not strange that the 
causes of many fires escape detection. In the first place 
many incendiary fires, if fully successful, destroy all traces 
of origin. The same is true of fires caused by electric 
wires, defective flues, spontaneous combustion, sparks, 
and many other obscure or hidden causes. In fact, when- 
ever fires acquire such proportions before their discovery 
as to prevent subsequent inspection of the points of origin, 
or when the amount of destruction is sufficient to obliterate 
any indication of the cause (in cases when the origin is not 
witnessed) that cause will usually remain a mystery. It 
will be readily seen that this very considerable percentage 
of fires of unknown origin renders anything like an exact 
estimate of the effect of the various hazards impossible, 
and one of the difficulties of making a scientific and accu- 
rate apportionment of rates is therefore at once obvious. 

The foregoing must be considered to be merely a rough 
general index of the numerous heads included in the very 
important subject of physical hazards. As the profession 
of fire underwriting progresses and develops, the investi- 
gation and safeguarding of these hazards is more and more 
passing into the hands of experts, and, indeed, the subject 
is one sufficiently comprehensive and complex to afford a 
life work to students of the best technical training. 

In this discussion we must now pass on to the considera- 
tion of the other grand division of hazards, usually called 



154 YALE READINGS IN INSURANCE 

moral hazards. Moral hazards arise from the personal 
(including the financial) circumstances which affect risks. 
They are indefinite, incapable of analysis, separation, or 
estimation, yet they are of the greatest importance in fire 
insurance. Some authorities believe that more fires are 
attributable, directly or indirectly, to moral or personal 
causes than to physical, and, while any such attempt to 
estimate the results of moral hazards must be largely 
conjectural, it is quite certain that they are accountable 
for a very large percentage of the fire waste. Moral 
hazard is said to exist in regard to a particular risk when- 
ever a benefit, real or supposed, direct or indirect, would 
ensue to any one, especially the owner, by reason of the 
destruction of the insured property; also, and nearly as 
important, whenever for any reason no one has a strong 
interest in its preservation. 

In other words, not only the desire to destroy, but also 
the lack of a strong desire to preserve, creates moral 
hazard, so called, and it is hard to say which condition 
is the more dangerous. The prospect of a profit from fire 
or the absence of a financial incentive to preserve a risk 
make it impossible for an insurance company to rely upon 
the exercise of that due care and diligence for its protection 
which is essential, if business is to be transacted at a profit. 

There are various ways in which moral hazards may 
arise which can be named and described. The possibility 
of their occurrence is patent to every one as soon as they 
are named, but to find out or know in advance that any 
of them exist in connection with a given risk is often be- 
yond our powers. Hence losses due to such causes can- 
not be avoided. Any cause which seriously injures the 
value of a risk or diminishes its productivity is likely to 
create moral hazard, if the risk be well covered by insur- 
ance. Therefore insurance companies avoid risks where 
for any reason there is doubt as to value or productivity, 
— summer hotels which have not succeeded, buildings 
which are likely to be condemned, mines where paying 



RATES AND HAZARDS 155 

quantities of ore have not been found, flour mills where the 
water power has failed, etc. All of these are pertinent 
examples. Any man would prefer money equal to the 
cost of such properties to the properties themselves. So, 
too, experimental properties, — temporary branch stores 
and new ventures of every description which have not 
demonstrated their earning power, must be handled with 
greatest caution. The mere fact that capital has been 
invested does not always indicate that value exists, and 
the rule of prudence and of indemnity as well, viz., "no 
profit to the assured from fire," points the way to the wise 
rejection of risks where this question of value is involved. 
Such risks are not only likely to be wilfully fired by a dis- 
honest insured owner, but, even in the hands of honest 
men, are not likely to receive that assiduous care and watch- 
fulness which men give to their successful enterprises. 
Indifference and carelessness differ only in degree from 
the actual desire for the destruction of property so far as 
the probability of its accomplishment is concerned. 

In view of the considerations mentioned above, insurance 
companies look with disfavor upon those risks where the 
amount of insurance carried exceeds the value of the prop- 
erty and are inclined to fear a moral hazard in connection 
with them. It goes without saying that such a condition 
would be dangerous where the owner is dishonest, and where 
he is honest the fact that no personal loss can come to 
him from a fire is likely to induce that carelessness and lack 
of precaution which constitute one species of moral hazard. 

Financial embarrassment and the pressing necessity for 
ready cash often create the most serious kind of moral 
hazard. A merchant with notes overdue or who sees failure 
ahead, or a farmer who cannot pay interest on his mort- 
gage, is often in a position where the ready money obtain- 
able from his insurance policies, even if not equal to the 
value of his property, would nevertheless help him tide 
over a pressing emergency. 

Another situation which frequently involves moral 



156 YALE READINGS IN INSURANCE 

hazard is when property of any kind becomes involved in 
litigation or where there is dispute as to ownership. In 
such cases divisible cash is much more available than prop- 
erty which must be liquidated, and everybody interested 
might well be benefited by a fire which would simplify the 
settlement of a dispute. Moreover, the enmities aroused 
in the course of litigation are themselves a source of danger. 

The foregoing remarks apply to moral hazards which 
arise in connection with the owners of property, but there 
are species of moral hazard which do not involve acts or 
neglect of the owner, but spring from the acts or desires 
of others. These chiefly arise from the ill-will of those to 
whom the property owner or his property is in some way 
objectionable, or who have been or are likely to be injured 
by the nature of the property itself or the kind of work 
carried on therein. Any building, such as a fertilizer 
factory, contagious hospital, dance hall or saloon, which 
interferes with the peace and enjoyment of a neighbor- 
hood or hurts the value of surrounding property, offers a 
constant temptation to those who may be injured by it. 
Its destruction would be a distinct benefit to them. Simi- 
larly, any property owner whose disposition and practices 
are such as to make numerous and bitter enemies is likely 
to feel the results of the hostility thus aroused through 
the burning of his property. 

It will be seen from the preceding pages that the ele- 
ments which go to make up hazards to which insured prop- 
erty is subject are numerous, complicated, and varied. We 
will now endeavor, briefly, to survey the methods used 
by insurance companies to measure these hazards, i.e., to 
fix rates or prices. 

Moral hazards may be dismissed at the outset; the) 7 
cannot be measured or charged, for usually they cannot 
be ascertained till after a fire. Their existence, however, 
greatly increases the fire waste and is responsible for the 
greater part of what are known as basis rates, to be later 
described, i.e., the irreducible foundation, incapable of 



RATES AND HAZARDS 157 

analysis, upon which all systems and every schedule of 
rates are based. 

In the early part of this course the principle was laid 
down that fire insurance is a tax, — a tax levied for a 
specific purpose, — to repair the fire waste. All agree that 
taxes are necessary evils, but there is anything but unanim- 
ity as to methods for imposing and collecting them. No 
other function of government causes such bitter debate, 
acrimonious dispute, public clamor, and individual dis- 
content as this matter of taxes. There is perhaps no other 
obligation resting upon citizens that is so constantly and 
ingeniously evaded. 

Now it is by means of a graduated scale of rates or 
charges that insurance companies collect the enormous 
sums required to recoup the provident among the losers 
by fire, and there is the same diversity of opinion, almost 
the same intensity of debate, among those who devise 
these rates as exists between protectionists, free-traders, 
and single tax theorists. Moreover, from the public which 
is taxed arises the same clamors of discontent, the same 
charges of inconsistency, the same endeavors to lessen the 
individual burden, which are to be noted in the process of 
collecting ordinary taxes, and too often, as in the case of 
such taxes, these complaints have some reasonable founda- 
tion. Also, as in the case of ordinary taxes, it frequently 
happens that the most clamorous objectors and the most 
enterprising in securing relief are to be found among that 
number who, if the truth were known, are taxed at too 
low a rate rather than too high. From the very nature of 
things these clamors and this discontent are inevitable, 
though as the process of making rates becomes more and 
more scientific and therefore more equitable, we may hope 
that both the discontent and the reason for it may be 
greatly lessened. That there is some ground for the discon- 
tent, all underwriters will agree, for the task of apportioning 
with absolute correctness and fairness the fire loss among 
the various classes of risks and to each individual of a 



158 YALE READINGS IN INSURANCE 

class, according to the hazard of each, is an absolutely 
impossible one. Even to approximate fairness is enor- 
mously difficult. This is partly because of the absence of 
reliable data and the impossibility of obtaining them. 
There are, broadly speaking, no constant factors in the 
rating problem. In life insurance, rates to-day are fre- 
quently based upon a mortality table constructed from 
the experience of seventeen companies in 1838, and these 
tables are still found to be substantially reliable, but 
there are no unchanging mortality tables in fire insurance 
experience. 

The proper basis for a table of rates, constructed on 
scientific principles, might well be thought to be the com- 
bined experience of a number of companies carrying 
similar classes of hazards during a period sufficiently long, 
and over a field sufficiently wide, to justify generalization. 
Such data have been hitherto unobtainable for various 
reasons, viz. ; lack of uniform system of classification, lack 
of cooperation owing to the furiously competitive con- 
ditions under which the business is carried on, and finally 
and chiefly, the difficulty of properly classifying those most 
numerous losses which result from fires communicated 
from one building to another, known as exposure losses, 
and those other numerous losses, the causes of which are 
unknown. Even were the necessary data obtainable and 
could they be properly segregated, their value as bases 
for rate tables might be open to question. In the last 
analysis the basis for the rate on any risk must be largely 
determined by the hazards, i.e., possible causes of fire, 
inherent in risks of the class to which it belongs. For 
example, the rate on a flour mill must be based upon the 
known dangers inherent to all flour mills, with such ad- 
ditions or subtractions as the peculiarities of the individual 
mill may make proper; but during the last forty years 
the process of milling flour has been revolutionized; in- 
stead of the old heavy millstones revolving slowly, we now 
have small steel rollers operated at a very high speed. 



RATES AND HAZARDS 159 

Formerly, owing to the imperfect apparatus used, flour mills 
were so filled with dust that the air in them was very like 
a dry fog, impenetrable to the eye in many parts of the 
mill. This dust was inflammable to the extent of being 
explosive. The best modern mills contain machinery 
which practically eliminates dust. It would be hardly 
too much to say that all processes, from the time the 
wheat enters the mill till the flour is packed in bags or 
barrels, differ from those in vogue forty years ago. Prob- 
ably it would also be within the bounds of truth to say 
that each year brings a new change in some part of the 
machinery or process. What is true of flour milling is true 
of most other manufacturing industries. One of the causes 
of the success of American manufacturers has been their 
willingness to discard old machines long before they are 
worn out for new ones better designed for their work, 
while foreigners cling to their old machines, both from 
unwillingness to change and from motives of false economy. 
A flourishing rubbish heap is often a sign of real progress. 

Again, the various processes and machines which have 
come into existence in the effort to make valuable the 
waste product of various industries have entirely altered 
the nature of many factories. For instance, in the case 
of packing houses, — in addition to the work for which 
such buildings were originally designed, viz. — the slaugh- 
tering, cutting, curing and keeping of beef, pork, ham, 
sausage, etc., there have been added the manufacture of 
fertilizer, of cooked, canned meats and vegetables, the 
manufacture of medicinal extracts, and other processes 
too numerous to mention, each of which brings a new 
hazard to be estimated and accounted for in the rate. 

Furthermore, there are certain changes in methods of 
heating and lighting and of using power, involving the use 
of gasoline, electricity, etc., which have greatly altered 
and are constantly, to a large extent, altering the hazards 
of the buildings where they are used. Every new machine, 
every new process, makes a change in the sum total of 



160 YALE READINGS IN INSURANCE 

hazards and therefore the carefully collected data showing 
the experience on any particular class of risks may at any 
time, by the invention of new machinery or by the discovery 
of a new process, chemical or otherwise, be rendered abso- 
lutely valueless, and the underwriter may be compelled 
to make new rates to cover hazards which have not en- 
dured long enough to furnish any experience whatsoever. 

Difficult as the accumulation of proper data and the 
ascertainment of the fire cost of each class might be, and 
despite the necessity for frequent revision and reconstruc- 
tion, owing to the changing nature of the factors involved, 
insurance companies might well undertake the task and 
endeavor to ascertain more closely the necessary basis of 
fire cost for each class of business as a foundation upon 
which to build a proper system of rates, were it not for 
the hostility of legislatures, and of the people as well, to 
any kind of combined or associated endeavor to fix or main- 
tain such rates. Such hostility, we must hold, arises from 
a failure to comprehend the true nature of insurance, and 
the further failure to apprehend the principle that a properly 
constituted rate is chiefly made up of factors which are 
not in the control of underwriters and which cannot be 
correctly ascertained and formulated by them except 
through associated effort and combined experience. The 
attempt to cure inequalities and injustices which occur in 
the making of rates by legal process springs from the same 
mental astigmatism which induces men to attempt by 
law to prevent fluctuations in the purchasing value of 
silver or of any other commodity. Fair, equitable, and 
adequate rates are a prime necessity, not only for insurance 
companies, but for the insuring public, for in the long run 
the premium income must pay the losses. In other words, 
adequate security demands adequate rates. Impairment 
of security, an undoubted loss to policy-holders, must 
result from inadequate rates. 

The foregoing remarks apply to the difficulties which 
attend the making of proper rates for various classes, but 



RATES AND HAZARDS 161 

even greater difficulties are met when the attempt is made, 
as it must be made, to fix an appropriate rate for each 
individual of a class. In life insurance no such differentia- 
tion is attempted. Every man insured at age twenty-nine 
under the same kind of contract pays the same rate, and 
it is assumed that every insurable life at age twenty-nine has 
the same expectation. In fire insurance, however, no two 
risks are exactly alike and every detail of every risk must 
be examined and its contribution to the total hazards of 
the risk estimated. Moreover, in fire insurance many, if 
not most risks, undergo frequent changes and must there- 
fore be re-examined and re-rated from time to time. It is 
this necessity for determining the proper charges and allow- 
ances for the numerous differences which characterize the 
construction, occupancy, location and exposure, methods 
of heating and lighting and extent of fire protection, not 
only for every class of risks, but also for every individual 
of each class, which constitutes the greatest practical 
difficulty to be overcome in making a fair assessment of the 
fire cost. 

Without trying to investigate the history of the various 
methods of classification which have characterized the 
business, or to give any account of the differing processes 
for making rates which have been attempted from time 
to time by insurance companies, interesting and instructive 
as those subjects are, we will now proceed to take up a few 
of the systems and methods by which rates are to-day made. 

Rates may be said to be made to-day by two processes: 
First, by what is known as the personal inspection or judg- 
ment rate system; and, second, by carefully prepared and 
more or less scientific schedules. 

The judgment system of rating is rapidly giving way 
before the use of highly complex and specialized schedules. 
It is open to serious and obvious criticism, yet has in times 
past served a very useful purpose and is not without its 
good features. A few words will sufficiently describe it. 
By means of a more or less complete system of classifica- 



162 YALE READINGS IN INSURANCE 

tion, companies ascertained in a rough way the average 
cost of many kinds of risks, and this information was put 
into the hands of their special agents or gradually absorbed 
by them in the course of their work. Formerly special 
agents did practically all of the work of making rates in 
company with local agents. When a town was to be 
rated, these average cost figures were used as basis or foun- 
dation rates. Usually towns were rated by committees of 
from two to five special agents who acted for all companies. 
No rule or regular method of procedure governs the making 
of rates under this system. The rates so made simply 
indicate the opinion or judgment of the rate-makers. Little 
attempt was made to analyze the factors which deter- 
mined the judgment of the committee as to each risk. 
Nevertheless, since that judgment was usually the result 
of the experience and observation of many years spent in 
such work, the rates made were in many cases quite satis- 
factory and equitable to a moderate degree. No attempt 
was made to take account of minor differences, but all good 
features or defects of construction and exposure, and also 
all the hazards of occupancy and processes, were lumped 
together, and if, as a whole, to the mind of the raters, they 
were sufficient to appreciably differentiate the particular 
risk from the average risk of its class, a penalty was added 
to, or an allowance was made from, the average rate which 
experience had shown to be about adequate. 

Such a system was fairly satisfactory during the years 
when buildings as a rule were in point of construction very 
much alike, but with the growth of improved methods of 
building, and with the increase and improvement of the 
apparatus for protection against fire, to say nothing of the 
great changes in business methods, such a system fails to 
discriminate properly between risks of the same class which 
may differ widely in many important respects. Moreover, 
the personality of the raters under the old system was a 
highly important factor — to such an extent, in fact, that 
different committees might produce quite different results 



RATES AND HAZARDS 163 

when rating identical risks. The system of schedule rating 
which attempts to take into account the various features 
of construction, exposure, internal hazards, and protec- 
tion against fire, which are peculiar to each risk, obviates 
these objections, though itself, as will be shortly seen, open 
to criticism of another nature. 

As already hinted, no perfect system of apportionment 
of the fire tax can be devised. On the whole, the system 
by schedules applicable to each class gives promise of 
development into a means of fixing rates which will be 
much more equitable and satisfactory than any other 
method which has yet been followed, and there is reason 
for hope, with more perfect statistics and a better appre- 
ciation of the relative potentialities of the different hazards, 
that the various schedules will ultimately develop until 
they come to be universally recognized by the public, as 
well as insurance officials, as satisfactorily solving, so far 
as it may be solved, the complex problem involved in 
making rates. 

In the early days of insurance history two rates only 
were known, — one for buildings of brick construction, 
another for frame, and these rates applied regardless of 
occupancy. Gradually, as the hazards of the different 
kinds of business came to be appreciated, a system of 
classification was begun which has been growing and en- 
larging until to-day, nor has its growth or enlargement by 
any means reached its limit. At the present time many 
companies divide their risks into over a hundred classes 
and further sub-divide each class according to construc- 
tion, i.e., whether brick or frame, and according to the class 
of the town or city, viz., whether protected or unprotected, 
in which the particular risk may be located. From their 
experience with these classes approximations are made 
by companies of the actual average cost of insuring each 
class, but in order to fix the prices for the individuals of a 
class there is required a mass of diagrams, statistics, and 
other data, showing the particular features of each risk, 



164 YALE READINGS IN INSURANCE 

which are almost infinite in number. This will be apparent 
from the statement that these data include more or less 
complete descriptions of practically all buildings in the 
central portions of all cities, towns, and villages of any 
size in the United States. 

Companies as a whole are estimated to expend over a 
million of dollars per annum for rating purposes. Single 
companies expend as much as $20,000 per annum for 
maps alone. 

The prime requisite for a system of rates is that it shall 
so far as possible be uniformly equitable; that is, it must 
compel each class of risk and each individual of the class 
to pay its proper proportion of the fire tax. To approxi- 
mate such a result, however, not only are the data before 
mentioned necessary, but the amount of insurance to be 
carried on each risk must be known. At least nine-tenths 
— Mr. Dean says nine teen-twentieths — of all losses are 
partial. The great majority are small as compared with 
the value of property insured. It is evident that, in case 
of a partial loss destroying less than one-half the value of 
an insured property, a man who carries insurance to, say, 
50 per cent, of the value of his property, secures the same 
amount of indemnity as the man who carries insurance 
amounting to 80 per cent., though the latter has paid a 
much heavier tax. It follows that where, as is usually 
the case, there is a fire department and water works, the 
man who carries insurance amounting to 80 per cent, of 
the value of his property is entitled to a lower rate than 
the one who carries insurance amounting to but 50 per 
cent, of that value. For this reason all properly devised 
schedules or tariffs for making rates are based upon the 
use of a co-insurance clause, usually the 80 per cent, co- 
insurance clause, which compels insurance equal to 80 
per cent, of the value to be carried, and penalties in the 
shape of higher rates are imposed where a lower percentage 
of insurance is carried. No other means has ever been 
devised, or is likely to be devised, which so fairly and auto- 



RATES AND HAZARDS 165 

matically apportions the insurance tax according to the 
value of property, just as ordinary taxes on real estate 
and personal property are supposed to be apportioned. 
One way of stating the principle involved is to say that the 
expectation of salvage is one of the factors involved in 
making rates. 

The schedule system, as its name implies, makes rates 
by applying to classes of risks and to individual risks 
certain predetermined charges and credits based upon the 
various factors of construction, occupancy, exposure, and 
protection against fire. In practice, in the several states 
or districts of the country, many different schedules for 
all classes of risks are used, though more than one attempt 
has been made to evolve a system of rating which might be 
everywhere applicable. We shall not be able even to 
mention many of these numerous systems, nor is it neces- 
sary, since for the most part they differ in detail rather 
than in principle. 

In the case of such simple classes as dwellings, schools, 
and churches, where the hazards are practically the same 
for each individual, the class rate is applied to every risk, 
differences being made only as between brick and frame 
and those under or beyond the protection of an efficient 
fire department. 

The schedules used in rating the different manufactur- 
ing classes, such as wood-workers, packing houses, flour 
mills, etc. (usually called special hazards), are made up 
substantially according to the following general plan: 

First. The standard or ideal building of the class in 
question is described. This building is standard, not only 
in arrangement and construction, but often as to its 
equipment for extinguishing fire. A basis rate is then 
assumed for a risk equaling the standard. This basis- 
rate, while arbitrarily fixed, is nevertheless the expression 
of the judgment of expert raters as to irreducible founda- 
tion of hazard incapable of analysis and made up of the 
numerous intangible and incalculable things (including 



166 YALE READINGS IN INSURANCE 

moral hazard and an allowance for unknown causes), 
which is thought to be inseparable from any risk of the 
particular class under consideration, no matter how per- 
fect its structure and arrangement may be. 

The basis rate having been determined, the various 
defects in construction, dangerous or improper factors of 
arrangement, and deficiencies in the nature and extent of 
the apparatus for fire protection are listed with a table 
of, usually fixed, charges for each; usually, too, there are 
some credits mentioned for extraordinary features of 
equipment or construction too infrequent to be conven- 
iently included in the description of the standard. Pro- 
vision is also made in such a schedule for a further credit 
or charge for the presence or absence of the 80 per cent, 
co-insurance clause, or some other percentage co-insur- 
ance clause, in the contracts. When a flour mill, for 
example, is to be rated, the assumed basis rate for flour 
mills is used as a starting point, and to it are added the 
various deficiency charges which may be found on in- 
spection to pertain to the particular mill to be rated. 
From the rate thus obtained a deduction is made for any 
credits to which the mill is entitled. When the rate thus 
made up is ascertained, the price to be charged is fixed 
by the allowance or charge for the use of the co-insurance 
clause above referred to. 

Many of these schedules are so minute and intricate 
as to require the services of an expert rater for their appli- 
cation, and therefore, and also for the sake of economy and 
uniformity, these schedules are applied to special hazards 
by men skilled in their use acting for associations of com- 
panies in the various districts. The factor of exposure 
(sometimes of great importance) may be covered by more 
or less elaborate charges; or more frequently in the case 
of special hazards, together with other additional objec- 
tionable features, is left to the judgment of the rater. 
This is because special hazards, as a rule, are more danger- 
ous to their surroundings than endangered by them. 



RATES AND HAZARDS 167 

Moreover, they are usually more or less isolated as to 
location, hence their chief hazards are internal. While, 
on account of the numerous and often hazardous processes 
involved and because inflammable material is frequently 
handled, these risks might be supposed to present unusual 
difficulties to the rater, they are on the contrary easier to 
rate with a reasonable degree of satisfaction, both to the 
companies and the owners, than the apparently more 
simple mercantile risks, which so far exceed them in number 
and value. The different processes and dangerous ma- 
terials are, in the case of special hazards, conspicuous, 
and their hazards comparatively obvious, hence their 
appraisal or estimate may be the more easily made. In 
these schedules many of the more serious defects are often 
penalized by very severe charges in order to compel prop- 
erty owners to remedy them; indeed, one of the chief 
merits of the schedule system of rating as a whole is that 
it encourages safe methods of construction, arrangement 
and protection, and recognizes them in the rates. 

Another and the chief argument usually advanced in 
favor of schedule rating is that, since it lists the various 
defects of each risk and the charges made for the same, 
property owners may know why the price which they are 
compelled to pay for insurance differs from that which 
may be paid by their neighbors, and hence may realize 
that they are not suffering from the effects of arbitrary 
discrimination or of personal judgment of the rater, since 
it is evident that the rate on their own property is governed 
entirely by its own faults or merits. 

In some states or districts as many as thirty different 
schedules for different classes of risks are in use. 

The rating of mercantile property, which comprises by 
far the most important class, both as to the number of 
risks and value, with which insurance companies have to 
deal, is the most difficult technical task which confronts 
the underwriter. 

There are many schedules in use for this purpose in 



168 YALE READINGS IN INSURANCE 

various parts of the country, most of which, however, have 
many points of resemblance. The following may be 
taken as a description of the average schedule of this kind 
used in towns and cities of moderate size — those used in 
the largest cities are more elaborate. 

In most states and districts the cities, towns and villages 
are divided into classes — commonly from four to six in 
number — according to the amount of protection afforded 
by the water works and fire department of each. Two 
basis rates — one each for brick and frame mercantile 
buildings — are then adopted for each class of towns. 
The basis rate is usually in the case of brick buildings 
predicated upon an assumed type of building adopted for 
that purpose and described in detail in the schedule. In 
order to determine the rate on any one building or its 
contents the proper basis rate is taken as a foundation, 
and to it are added the fixed additional charges made 
necessary by its structural defects, which are usually 
listed with more or less minuteness in the schedule, a 
stated charge being made for each defect. To the rate 
of the building thus determined additions are made for 
the exposure hazards from adjacent risks according to 
the table or rule provided in the schedule. From the 
figure thus obtained a deduction is made on account of 
credits allowed for those features of construction, or of 
individual fire protection, which may be permitted by the 
schedule. The resultant rate is called the unoccupied 
building rate. It is then further increased by a charge 
made on account of the nature of the occupancy, such, for 
instance, as a drug store or a dry goods store, and thus 
becomes the final building rate. 

The rate on the contents is then made, frequently by an 
addition to the building rate, named in the schedule itself 
as applying to the particular kind of contents under 
consideration; but more often all kinds of contents are 
classified roughly into from two to four or five classes, 
and an additional charge, over and above the building 



RATES AND HAZARDS 169 

rate, to be applied to the contents, is provided for each 
class, and is used in every case where contents which may 
be embraced in that class are found. 

The foregoing applies to the rating of brick mercantile 
buildings and their contents. Rates on frame mercantile 
buildings are usually made by a more simple process. 

In the first place, all frame mercantile buildings are 
esteemed to be substantially alike for the purpose of 
insurance, the differences in point of construction which 
are recognized being confined to metal roofs and brick or 
iron coverings for side walls. A basis rate is agreed upon 
for frame buildings in each of the various classes of towns 
into which a district may be divided, and charges are 
made for occupancy and exposures. These charges, so 
far as occupancy is concerned, are usually very few in 
number. Where frame buildings are concerned the rate 
on contents is seldom, if ever, higher than the rate on the 
building itself, and very often less than the building rate, 
because a high rate on such a building is usually due to 
a heavy exposure hazard, which, so far as the contents 
are concerned, may be overcome by their hasty removal 
when the danger of fire is imminent. 

The treatment of exposures in these numerous schedules 
shows great variety of practice, especially as regards brick 
buildings. In fact, for the most part this important 
feature in the rating of mercantile buildings and contents 
has had very inadequate treatment. When brick build- 
ings are exposed by other risks, one method, very fre- 
quently used, is to make a fixed charge for unprotected 
openings in side walls without regard to the character of 
the exposure. Another is to add to the rate of the exposed 
risk, where there are unprotected openings, some percent- 
age of the rate of the exposing risk, according to its dis- 
tance from the risk to be rated. 

Many tariffs, however, leave the question of exposure 
charges to the judgment of the rater, for it is difficult, 
especially in the case of brick buildings, to provide a satis- 



170 YALE READINGS IN INSURANCE 

factory and workable rule for such charges in a schedule 
designed to be comparatively simple. For frame build- 
ings there are usually definite rules in the shape of a heavy 
fixed additional charge over and above the basis rate for 
each frame building within a given distance — usually 
20 feet — of the building to be rated. Thus, if a frame 
building unexposed carries a basis rate of 1J per cent., 
T 7 o 5 o of 1 per cent, will be added for every frame building 
exposing it within 20 feet, and also for every frame build- 
ing which goes to make up a continuous row of wooden 
buildings up to some arbritary limit, such as 8 per cent., 
which is assumed to cover the most dangerous hazard 
which can be created by a combination of frame mercantile 
buildings. It will, of course, be understood that the basis 
rates, as well as the increments of charge made for ex- 
posures, vary in the schedules used in different parts of 
the country. 

As hinted before, two attempts have been made to 
evolve systems or schedules for rating mercantile property 
which might be universally used. The first of these 
schedules was prepared by a committee of eminent under- 
writers under the chairmanship of Mr. F. C. Moore, then 
president of one of the largest American insurance com- 
panies, and is called the "Universal Mercantile Schedule." 
It, or some modification of it, is used in many of the large 
cities of the country to-day, including New York, Cleve- 
land, Denver and many others, and it is, so far as results 
yet obtained are concerned, the most important of any 
of the tariffs which have ever been issued. It is also, of 
all rating schedules, the one which has been most carefully 
and minutely elaborated and adjusted to meet the almost 
infinitely varied combinations of the factors of construc- 
tion, occupancy and protection which are to be found in 
the mercantile buildings of a large city. 

This schedule was a great advance beyond anything 
before known in the history of scientific rating and has 
exercised a very important and growing influence upon 



RATES AND HAZARDS 171 

the framers of other schedules subsequently made, many 
of which are but imperfect adaptations of the Universal 
Mercantile Schedule. It is an extremely complicated and 
intricate schedule and cannot, therefore, be described or 
discussed in detail in the limits of this paper. A few 
extracts from the writings of Mr. Moore in regard to it 
will be given, which, in connection with what has already 
been stated in regard to schedule rating, will enable some 
idea of its purpose and scope to be formed: (It is sug- 
gested in this connection that the student consult Mr. 
Moore's book "Fire Insurance and How to Build.") 

"The mere fact that there are more than a hundred 
features of construction in a single building which should 
enter into the consideration of its rate, irrespective of 
nearly forty features of its city or environment, nearly 
forty more different features of fire appliances, to say 
nothing of more than a thousand possible hazards of 
occupancy; and the further fact that no individual knowl- 
edge is equal to the task of putting a price upon so many 
items, nor any individual memory capable of remembering 
them, proves, without further demonstration, the necessity 
not only of conference to secure combined knowledge for 
fixing prices, but, also a printed record or schedule, to 
prevent omissions or mistakes." 

"In 1891 a committee of four underwriters was appointed 
to prepare a schedule for rating mercantile risks which 
should be universal in its application throughout the 
country. Early in their deliberations they reached the 
conclusion that such a schedule should be formulated 
upon the following lines, and that it should recognize: 

"First. A key-rate — as to which various cities and 
towns differ. 

"Second. Charges for variations from standards of con- 
struction — which ought to be the same everywhere. 

"Third. Charges for hazards of occupancy — which 
ought to be the same everywhere. 

"Fourth. Charges for insuring contents according to 



172 YALE READINGS IN INSURANCE 

their susceptibility to damage — which ought to be the 
same everywhere. 

11 Fifth. The variation of these charges, according to the 
construction of the building. Clearly the same amount 
should not be added, even for the same stock, to two 
different buildings where one is an exceptionally good 
building and the other an exceptionally poor one; there 
should be more difference between the building and stock 
rate in the one case than in the other. 

"Sixth. The treatment of fire extinguishing facilities, 
proximity to hydrants, etc., for the particular risk rated, 
according to circumstances; it being clear that if the risk 
is within reach of hydrants, steam engines, etc., and on an 
eight-inch or larger water main, it should rate differently 
from another of like kind, even in the same town, if the 
other risk be not so fortunately located." 

"So in other items or features of the schedule, the com- 
mittee found it necessary to go into every detail of hazard, 
leaving as little as possible to the judgment of a rating 
expert, so as not only to save his time and thought at 
every stage of the rating process, but to prevent, also, 
those inconsistencies of rating in risks of one and the 
same hazard, resulting from fluctuations of judgment, 
which so often produce dissatisfaction on the part of 
owners and result in appeals for legislative interference 
with rating organizations." 

"First. A standard city was conceived and described. 
It involved level and wide streets, gravity water works, 
adequate pipe service and other features fully explained. 

"Second. A standard building was described, which 
may be regarded as a model of ordinary construction, not 
fire-proof. 

" Third. A key-rate. 

"The basis rate or starting point for rating a standard 
building in a standard city was fixed at 25 cents, after 
careful consideration of the experience tables of the com- 
panies." 



RATES AND HAZARDS 173 

Since buildings of this class are to be found rarely, this 
was of course pure assumption. 

"From this starting point or basis rate of 25 cents, and 
to obtain the key-rate of any city, or that figure at which 
a standard building in the city should be rated, additions 
were made according to the deficiencies of the city as to 
water works, fire department, building laws, inaccessible 
or narrow streets, etc., etc. This key-rate, so determined, 
is thereafter used to obtain the rate of any building in the 
city to be rated by adding to it charges for its deficiencies 
from the specification of a standard building." 

For the purpose of rating contents of buildings and in 
order to make occupancy charges, no fewer than 1287 
varieties of contents are listed, each with its appropriate 
fixed charge to be added to the building rate; and also a 
different charge to apply to the contents themselves, over 
and above the final building rate. Moreover, a separate 
application for credits for fire protection is provided for 
the contents as compared with the building. 

"No schedule should be framed upon a basis which does 
not recognize a certain named percentage of insurance 
to value." 

"The universal schedule, however, does not enforce or 
require any particular amount of insurance, but simply 
adjusts itself (by reductions from ascertained rate accord- 
ing to stipulated account of co-insurance) to whatever 
amount the property owner elects to carry." 

The chief objection to this, or in fact to any system of 
schedule rating, is the necessity for the constant use of 
assumptions, not only in determining the basis rates, but 
in making the charges, for each defect of the construction, 
or for occupancy, which go to make up the final rate. 

A great deal of time and a vast amount of comparative 
research has been expended in the endeavor properly to 
appraise the dangers incident to all the various features 
of construction, protection, occupancy and exposure, yet 
it is manifestly impossible from any obtainable record of 



174 YALE READINGS IN INSURANCE 

experience to assert that a retail drug store, for instance, 
will make proper an addition of exactly 10 cents to the 
building or an addition of exactly 50 cents to the rate on 
contents over and above the building rate in all cases. 

A tariff has been devised by Mr. A. F. Dean, of Chicago, 
called by him a " Mercantile Tariff and Exposure Formula 
for the Measurement of Fire Hazards/' which differs 
radically in many respects from the "Universal Mercantile 
Schedule," and which has come into very general use in 
the western states. This tariff is intended to render some 
of the defects just mentioned less important, and is, 
moreover, founded on a different conception of the prob- 
lem of rating. Instead of endeavoring to establish a 
basis rate for a standard risk in a standard city, Mr. Dean's 
tariff divides cities into six classes, beginning with villages 
which have no protection whatever and which are known 
as towns of the sixth class. This is a very suitable basis 
for such a classification since its definition is simple, its 
existence real and unchanging; while on the contrary our 
ideas of a standard city are likely to change from time to 
time. From this as a starting point towns are graded 
according to their protection up to the first class, which 
includes all cities having protection in the way of water 
works and fire department of exceptional completeness 
and efficiency, and better than those classified under 
sections 2 to 6 inclusive. Moreover, for the purpose of 
rating, provision is made for the adoption, as a starting 
point, of a one-story, brick building of ordinary construc- 
tion located in a town of the sixth class. This kind of 
building is fully described in the tariff. Such buildings 
are common in towns of that class. However, this tariff 
does not attempt to name the basis rates. They are sup- 
posed to be adopted or selected in each state or district 
by raters who have had . experience therein. This does 
away with the necessity for making ideal standards and 
estimating basis rates therefor. Concerning this matter 
of adopting basis rates, Mr. Dean holds that the experience 



RATES AND HAZARDS 175 

of underwriters enables them to estimate more readily 
a proper rate for an ordinary building, such as may be 
found in great numbers, than for an ideal standard, which 
represents a class with which insurance companies have 
had very little if any experience. Nothing more simple 
could be thought of as affording a starting point or basis 
rate than the one-story building selected by Mr. Dean; 
nor could any risk be found for which experienced under- 
writers could more readily or intelligently name a proper 
rate. 

This basis rate having been decided upon, additions or 
deductions are made for good or bad features of con- 
struction, occupancy, protection or exposure, but since 
the average building is taken as a starting point these 
charges and credits will be fewer in number than where a 
standard building is taken as the foundation, and charges 
made for the numerous deficiencies which every ordinary 
building has. Moreover, instead of making these charges 
and credits by means of arbitrarily fixed amounts, the 
additions and subtractions are made by the percentage 
method. For example, in the " Universal Mercantile 
Schedule/' ten cents is added to the rate of a building 
having a retail drug store therein, whereas in Mr. Dean's 
tariff a percentage of the previously ascertained building 
rate is added for this occupancy, and a similar method is 
used in making charges and credits for various features 
of construction. The system employed for estimating 
the proper percentage additions to the rate on account of 
occupancy is especially ingenious and logical — two addi- 
tions are made for most occupancies, one for the causative 
hazard of the contents, i.e., the danger which their pres- 
ence begets, the other for the extent to which the contents 
are likely to aid the spread or intensity of a fire. 

Similarly, the percentage plan is followed for establish- 
ing basis rates for one-story brick buildings in towns of 
the other classes; that is, the basis rate for a town of the 
third or fourth class would be ascertained by deducting 



176 YALE READINGS IN INSURANCE 

a certain percentage from the basis rate selected for a 
similar risk in a town of the sixth class. 

The chief object in adopting the percentage system for 
variations in the factors affecting rates is that it preserves 
the relativity of charges and credits which are made in 
rating. It is manifest that where a basis rate, for ex- 
ample, is 40 cents, an additional charge of 10 cents for 
occupancy on account of a drug store is much more severe 
than where the basis rate is, say, 80 cents. With the 
charge for a drug store occupancy of 10 per cent, on the 
basis rate, however, this inequality would be obviated. 
Again, the charge of 12 cents for open, unprotected eleva- 
tors in a building of moderate area and, say, three stories 
in height, and which, in consequence of these features, 
enjoys a low rate, is relatively very much heavier than the 
same charge in the case of a large six or seven-story build- 
ing of great area which bears a high rate. In the latter 
case 12 cents would probably be about one-tenth of the 
total building rate, while in the smaller building it would 
be at least 20 per cent. Moreover, an open elevator in a 
building of unusual height or area is a much more serious 
defect, and is likely to be responsible for much greater 
destruction of property than a similar elevator located in a 
small building of moderate height. The same reasoning 
might be applied to the credits or deductions made for 
favorable features. In support of his views on this sub- 
ject Mr. Dean says: 

"If, under the law of averages, a thousand buildings of 
given construction, occupancy and protection will show 
a given ratio of loss to value during a given period, under 
the same law a thousand flues, hatchways, skylights, 
well-holes, wooden ceilings, or other parts of the building, 
of given construction, will each contribute its unvarying 
quota of this ratio, hence the several parts stand in a 
position of unchanging relativity, not only to the whole 
but each to the others. Fire hazard is, by nature, a net- 
work of relativity. In constructing a basis schedule we 



RATES AND HAZARDS 177 

necessarily select certain features of hazard as separable 
and attach to each of these a charge, while to the residue 
consisting of unanalyzable parts we attach a lump charge 
and call it a basis rate. There is no intrinsic difference 
between the charge we call a basis rate and the other 
charges excepting that it includes all things too obscure, 
indefinite or unimportant to schedule. If under the law 
of averages the relativity between the whole and its parts 
does not change, and the relativity among the several 
parts themselves is constant, it follows that each charge 
bears an unvarying relation to the basis rate, or, con- 
versely, the basis rate a constant relation to the other 
charges. This being the case, it is false logic to treat the 
basis rate or any of the charges as a dissociated element 
of hazard, for every change in basis rate or charge involves 
a disturbance of their mutual relativity. The real question 
in establishing every charge is, what ratio of the total loss 
will this feature of hazard under the law of average prob- 
ably contribute? When this ratio has been established 
by judgment and experience, it should take its place in 
every schedule as a fixed ratio bearing a constant relation 
to the whole and its several parts." 

Under this tariff the rates on the contents of brick 
buildings are established through a differential added to 
the occupied building rate. This differential is based upon 
the damageability of the contents by water, smoke, heat, 
breakage, etc., as the result of fire, and represents the rela- 
tive value of fire department protection to contents as 
compared with its value to the building itself. The tariff 
contains a table of differentials referring to about four 
hundred different kinds of contents, and further graded 
to correspond with ten different sets of basis rates, each 
set including a basis rate for a town of every class. These 
differentials are also arrived at by the percentage method, 
by averaging the differentials contained in many previous 
tariffs made for unprotected towns, and then subjecting 
these differentials to an ingenious scale of percentage 



178 YALE READINGS IN INSURANCE 

comparisons with the building as affected by the various 
grades of fire protection, according to the theory that 
the greater the damageability of the contents the less 
valuable to them — as compared with the building — is 
the protection against fire afforded by water works and 
fire departments. 

A separate schedule based upon similar principles is 
devised for frame buildings, by which rates for frame 
buildings and their contents in a city or town of any class 
may be readily ascertained when once a basis rate has been 
adopted for an ordinary shingle-roof, frame building in a 
sixth class town. One important difference between the 
brick and frame schedules to be noticed* is, that the dif- 
ferential for contents in the case of exposed frame build- 
ings depends upon their removability instead of their 
damageability, and a table of contents graded according 
to their removability is provided. 

The matter of exposure charges and hazards is treated 
in a separate department of the tariff called the exposure 
formulae. These formulae enable the rater to make 
additions to the rates of both brick and frame buildings 
and their contents on account of exposure hazards by 
means of a highly ingenious exposure table, graduated 
with reference to the construction of buildings, the dis- 
tances between risks which affect each other, the amount 
of fire department protection, and the hazards of the ex- 
posing risks. This table is also made up on the percentage 
system, each risk radiating a percentage of its own rate 
or absorbing a percentage of the rate of the adjoining 
risks. The theoretical considerations upon which this 
table and its applications are based are given below in 
Mr. Dean's own language: 

" External exposures are classified under three heads: 

"a. Radiated exposure, consisting of the proportion 
of its own hazard a risk radiates toward exposed risks. 

"b. Absorbed exposure, consisting of the proportion 
of radiated hazard absorbed by an exposed risk. 



RATES AND HAZARDS 179 

"c. Transmitted exposure, or the proportion of the 
hazard a risk absorbs from one side, that is transmitted 
by it to a risk on the other side. 

" Under the above classification, it is proper to bear in 
mind: 

"First. That every exposing risk radiates some ratio 
of its own hazard towards exposed risks. 

"Second. That every exposed risk absorbs some ratio 
of this radiated exposure. 

"Third. That every risk transmits some ratio of the 
hazard it absorbs. 

"Fourth. That radiated, absorbed, and transmitted 
exposure are all modified by structure, clear space and 
fire department protection. 

"In view of the numerous ratios and ratios of ratios 
found in the problem of measuring exposures, the necessity 
for some fixed standard of comparison is clear, because 
a standard is the first essential in all measurement — it is 
equally clear that as ratios are to be measured the standard 
must be a ratio and not a quantity. Again, if we view 
exposure from the standpoint of cause and effect, it is 
evident that radiated exposure is to be taken as cause; 
hence it is necessary to select some ratio of the hazard of 
the exposing risk as a standard. 

"In selecting any standard of measurement, it is proper 
to choose that which is most generally available and most 
free from change. These qualities are found in the great- 
est degree, perhaps, in the exposure of frame buildings by 
frame buildings. In existing tariffs, there is substantial 
agreement in granting that a frame building transmits 
all the exposure radiated towards it by other contiguous 
frames, and while there is a considerable diversity in the 
ratio of radiated exposure in the several tariffs, they ap- 
proach nearer to uniformity in this ratio than in any other 
feature of exposure. An examination of different state 
tariffs shows a range of exposure charge in unprotected 
frame rows from about one-third to one-half the hazards 



180 YALE READINGS IN INSURANCE 

of the exposing risk. The average of all tariffs approxi- 
mates closely to 40 per cent., while under the different 
grades of protection this ratio decreases in proportion 
to the protection. 

"It can hardly be disputed that, under like protection, 
like buildings radiate like ratios of their own hazard, and 
if this be true the standard of radiated exposure under 
any given grade of municipal protection should be the same 
everywhere; hence all tariffs should agree in the adoption 
of a common standard." 

Whatever may be thought of the brick and frame sched- 
ules, and though founded upon scientific principles and 
worked up according to scientific methods they will, un- 
doubtedly, be criticised as to details, it is the writer's 
belief that the exposure formulae, at least, will come to 
be recognized as exhibiting the most satisfactory, logical 
and adequate treatment known up to this time, of this 
highly complex and hitherto maltreated department of 
the science or business of making rates for mercantile 
risks. A detailed explanation of them is impossible 
within the limits of this paper, which, indeed, must be 
considered as an introduction to the study of rating sys- 
tems rather than an exposition of their methods and prac- 
tice. Moreover, some little study is required in order 
to understand the use, or to appreciate the great value 
of these exposure formulae. Nor would it be possible 
for any one without large experience to realize the difficul- 
ties which must be overcome in any successful attempt to 
construct a logical and workable scheme for the proper 
measurement and distribution of exposure hazards. Mr. 
Dean's tariff formulae as now published are intended for 
use in towns and cities of ordinary size and would require 
additional elaboration for use in the largest cities. There 
is no reason why tariffs or schedules based upon the same 
principles should not be made for all kinds or classes of 
risks, manufacturing as well as mercantile. 



CHAPTER IX 

SCIENTIFIC FIRE-RATING 
II 

All forms of insurance are alike in two things; they 
indemnify for loss, and they do so by means of an applica- 
tion of the laws of probability. In gambling parlance, 
insurance is "a hedge." That is to say, it is the direct 
opposite of gambling. It does not take chances but, 
instead, cancels them. Man is, by the laws of nature, 
subject to various uncertainties of fortune, as to health, 
life, preservation of property, etc. This liability he can- 
not escape directly, but he may nullify the financial hazard 
by means of insurance. Thus insurance is to him not a 
gamble but a hedge. 

It is sometimes erroneously said that companies which 
engage in insurance are gambling. If they took a few 
risks only, the charge would be true; but we shall see that 
the fundamental principle of the law of probabilities is 
that when a large group is considered, chance is very 
nearly eliminated and the aggregate loss may be estimated 
within narrow limits, so that the purveying of indemnity 
is no more a speculation than dealing in sugar or calico, 
nor indeed so much. Therefore, by means of insurance we 
find that not merely is the hazard of the individual offset, 
but also that the hazard when passed over to the company 
and combined with others, results in a reasonably reliable 
loss ratio which is transmuted into a moderate tax upon 

1 By Miles M. Dawson. Reprinted from pages 56-67 of the 
"Proceedings of the Thirty-Second Annual Meeting of the Fire 
Underwriters' Association of the Northwest," 1901. 

181 



182 YALE READINGS IN INSURANCE 

all who, being subject to the same risk of loss, have thus 
sought protection. 

The laws of probability were practically unknown to the 
ancients, though insurance in a very interesting form was 
practised in Greece and Rome. The form was in loans 
to owners of vessels and cargoes at rates of interest far 
exceeding the usual upon safe securities, it being stipulated 
that the loan should not be repaid at all if the property 
were destroyed. Insurance, therefore, made its first 
appearance as the handmaid of commerce, which office has 
been in later centuries performed by it in a degree that 
was inconceivable then. Of course, the additional interest 
upon such a loan was in reality an insurance premium, 
charged as a consideration for the risk. Indeed, as has 
been shown in our day, a considerable part of the interest 
upon loans is in almost all cases really a premium charged 
because of the risk of the principal. But in those days, 
while the thing was known, its nature was not fully under- 
stood. 

The mathematical law of probability may be stated as 
follows: If in a large group of persons, for instance, to each 
of whom a certain thing appears a priori equally likely to 
happen, it does actually happen within a certain time to a 
certain number, then the risk that such will happen to one 
person in the group within such time may be represented 
by a fraction of which the number to whom the thing 
happened is the numerator and the number composing the 
group is the denominator. This may be stated in another 
way which may be even clearer, viz.: This fraction will 
accurately represent the probability that a given man in 
the group was one of those to whom the thing has happened. 
For, indeed, the application of this principle to future 
happenings calls for an additional generalization and also 
for careful testing to determine whether the group was 
large enough to furnish a reliable average and whether 
the classification really admitted none but like hazards. 
Even then the result must be accepted as a guide for future 



SCIENTIFIC FIRE-RATING 183 

estimates of the value of a hazard with caution, until 
repeated testing has proved the correctness of the deduc- 
tions in every respect. 

But, so far as the mere law itself is concerned, it is as 
well stated when we seek the chance that the event has 
happened to a particular man in the past as when we 
estimate the probability that it will happen to a given man 
in the future. It is this unity of the law of probability 
that makes it useful as a means of prevision, and, therefore, 
as a foundation for insurance. We know the law to be 
reliable and we surmise that this, in turn, is because other 
laws, causing the phenomena which we are attempting 
to forecast, are themselves working with even and reliable 
regularity. In other words, our study of probabilities 
leads us to the conclusion that, strictly speaking, there is 
no such thing as chance — though, so far as the power of 
the individual to control events is concerned, of course 
there is and must be; but that causes are continually at 
work which explain all that happens and that, if our 
knowledge of these causes were perfect, we should find 
ourselves in a world of certainty. It follows, therefore, 
that no grouping is or can be perfect, for, if we could 
know all the forces that are in operation, we should not 
merely know which in the group were out of place there but 
we should also know to which alone the event would happen 
and they alone would be in place there. It follows, there- 
fore, that it is our task to classify and reclassify, knowing 
that at best the grouping is imperfect and knowing also 
that if it ever became perfect, not only would our labors 
be at an end, but that there would no longer be probabili- 
ties, but merely certainties, and that insurance would be 
impossible. It is clear then, that insurance and the science 
of probabilities are both ephemeral things which will pass 
away when man's knowledge is all-embracing. Perhaps, 
however, the time during which this omniscience is evolv- 
ing, will be sufficient for our purpose; and we have at least 
this encouraging consideration that, if the grouping could 



184 YALE READINGS IN INSURANCE 

be perfect, as our critics sometimes think or at least say 
that it ought to be, it would also be useless. Strangely 
enough, then, its utility depends upon its incompleteness 
and imperfection. But we are not on that account to 
neglect grouping things together which seem to us most 
nearly alike ; for, do what we will in that regard, there will 
be imperfections enough in the selection, you may be sure. 

In fire insurance, where the determination of the amount 
of a premium has been empirical, as a rule, you have seen 
a remarkable development in classification which, had it 
been accompanied by a similar evolution of scientific 
rate-making, would by this time have put you in possession 
by easy stages of the most wonderfully and perfectly 
adapted system known. Unfortunately, it was not so 
accompanied and the work of determining cost ratios, 
which are hazard ratios, has been deferred until this 
complexity has been introduced by the necessities of com- 
petition. The most serious and important obstacles in 
the way of at this time making fire-rating a science arise 
from the great complexity of these classifications, none 
of which existed in the beginning. We have classifications 
by construction, by occupancy, by exposures, and each 
of these has sub-classifications, almost without end. 
Then, as we shall see, it is also considered desirable to 
group by territories and likewise by time, measured by 
terms of years if not by single years. It is this which 
makes the labor of preparing the ratios seem so great, 
and, indeed, to many impossible — this, and the enormous 
mass of data involved in each group. If the work had 
been entered upon when there was little attempt at classi- 
fication, it would have been easy; and since it would have 
kept pace with the complexity which time has introduced, 
and indeed would doubtless have suggested and deter- 
mined that complexity, it would not now be difficult to 
keep the machine in motion. 

In life insurance, to digress for a moment, the develop- 
ment has, in this country especially, also been one-sided. 



SCIENTIFIC FIRE-RATING 185 

The science of probabilities, together with its application 
to rate-making and other problems, has been brought to 
great perfection; but the grouping has been into one class 
only, viz.: lives, accepted as first-class, while lives which 
fell below the standard were unable to secure insurance at 
all. Naturally such a system has resulted in many lives 
being accepted which were regarded as on the line or very 
near it; and within the year the American Society of 
Actuaries has, on the suggestion of Emory McClintock, 
Actuary of the Mutual Life, and the greatest living member 
of the profession in this country, began as its first great 
work, to construct with the cooperation of the principal 
companies mortality tables from their experiences for 
classes of lives, distinguished by heredity, occupation, 
personal characteristics, and history. This is a great task, 
comparable only, perhaps, to the work which we are dis- 
cussing, that of classifying and ordering the statistics of 
fire insurance companies, so as to determine the ratios 
of loss as to each class. It is significant, perhaps, that 
both branches of insurance, which have in the past been 
so one-sided in the development of their rate-making 
systems, though in ways diametrically opposite, should 
now apparently be approaching the same goal of system- 
atized and thoroughly classified statistical tables, showing 
the cost by classes. Fire insurance should, it seems to 
me, come out with the most perfect and useful tables; 
and what is needed in life insurance is, perhaps, not so 
much further classification of lives that have all along been 
accepted but information as to rates which would be safe 
for the one-sixth part of those who have applied that have 
been rejected. This information the investigation will 
not develop and consequently the experiments in the field 
of insuring impaired lives are being made by means of 
empirical modifications of the rates with eyes open for 
everything that can guide the classification. The fire 
insurance companies have, taking all of them into account, 
embraced about all classes of property that are subject 



186 YALE READINGS IN INSURANCE 

to the hazard of destruction by fire. The one-sided 
development of the business has not been narrow as has 
been the case in life insurance to a lamentable degree. 

Perhaps a definition of the meaning which is by me 
attached to the word "empirical" may not be out of 
place. The fixing of a price, however cleverly and shrewdly 
done, without actually computing the costs, is an empiri- 
cal act. Most prices are thus fixed, to a great degree; for, 
while the sellers are loth to sell for less than cost, circum- 
stances at times compel it and, on the other hand, they 
are rarely slow to accept large profits over the cost if 
opportunity offers. But it is another matter for one to 
be offering his goods in the market without knowing 
whether the price he names is above or below the cost. 
This was the condition, however, in railway rates until 
very recently. There the rule of the markets: " Charge 
all that the traffic will bear" was and is yet followed; but 
there is this difference between the old days and these, 
that then the wisest managers did not know when they 
were underbidding the cost, while now there is close figur- 
ing done continually to determine that very matter. 
The situation in fire insurance has been similar to this. 
In both cases, it reflects great credit upon the acumen, 
skill, and judgment of the men who have directed the busi- 
ness that the consequences have not been more ruinous; 
for they had nothing but the general result from year to 
year to guide them. 

In railroading, I have been informed, the old system, 
while frequently bringing out reliable profits from the 
whole business from year to year, was found to have 
caused the greatest inequalities and inequities, when it 
was once thoroughly examined into. It has been reported 
that the hasty and imperfect investigation of fire insur- 
ance experience that was recently made, showed a similar 
state of affairs. I may add that this was also until re- 
cently the fact, in a large degree, in a business so remote 
from insurance as banking. Bankers, whether making 



SCIENTIFIC FIRE-RATING 187 

or losing money on the whole business, have not infre- 
quently had little idea which customers, aside, of course, 
from the largest of them where the facts stuck out, as it 
were, paid a profit to the bank or even compensated it 
for services rendered. But in the best and largest banking 
houses this is now changed and close track is kept of each 
account by an infallible system, so that the banker knows 
of a certainty whether the account is profitable. Thus, 
in leading New York banks, the account is duplicated by 
entries, showing when the value of deposited paper is 
actually reduced to possession by collection of the same. 
Similar investigations also as to the cost of collecting 
caused the adoption of the charge for collection of out- 
of-town checks by the New York Clearing House. 

You will observe that in all the four great businesses 
which I have mentioned, fire insurance, life insurance, 
railroading, and banking, the development has been from 
dealing with heterogeneous or mixed groups as if they were 
of one sort, to dealing with smaller and more thoroughly 
homogeneous groups. It is the mastery of details that 
counts in business nowadays and, the larger the business, 
the more imperative is the demand for this classification 
and study of details. 

The more classifications there are to be handled, the 
larger must be the statistical data from which deductions 
are made. The reason for this is that each classification 
stands wholly or in large part by itself and the ratio of 
loss must be determined for it separately, just as if it were 
the only class. Laying aside the question for the time, 
whether one period, on account of improvements or the 
contrary, is to be considered to have involved more or 
less risk of fire, the groups can be made up of different 
years' exposures, the losses for various years in that class 
being summed also to make a total. In this way, a suffi- 
ciently broad basis may sometimes be found for ratios 
in a class where the exposures in a single year are too 
few to yield a reliable average. The enormous mass of 



188 YALE READINGS IN INSURANCE 

details which make up the experiences of the fire insurance 
companies is, in view of these things, seen to be a benefit 
and advantage, and perhaps well worth all the additional 
labor which it entails. For, by reason of the great abun- 
dance of the material, it ought to be able to attain at least 
the following desirable ends, viz.: Thoroughly reliable 
conclusions as to the cost of insurance as to all the larger 
and more important classifications, including much infor- 
mation concerning the causes of fires in these classes, 
giving a basis for extra charges and for credits as well; 
reasonably definite measurements of the hazards in all 
the less important classifications, the data being in each 
case much more plentiful than could otherwise have been 
expected. 

The value of a broad basis is well known to you all, and 
yet I am sure that an illustration will not be out of place. 
Common sense teaches us that, for instance, in tossing a 
cent the chances are even whether it shall turn up head or 
tail. But if it be thrown but once, it must have turned up 
one or the other, and if a judgment were based upon that 
throw only, we would have a certainty. And experience, 
as well as reason, teaches that there is no certainty that it 
will turn up once one way and once the other in two throws; 
nor just half the time one way and just half the time the 
other way in four throws or any other small number of 
throws. But what we mean by saying that the chances 
are even, is that in a very large number of throws the 
number of heads and the number of tails will be nearly 
the same, and that in an infinite number of throws they 
would be just the same. We expect the ratios found by 
actual throwing the coin, to correspond more closely to 
the chances which we determined by reasoning about the 
matter, the larger the number of throws. In the same 
way, the average fire loss which is drawn from a very large 
number of exposures will more accurately correspond to 
the real probability; and, other things being equal, it will 
be more reliable, the more exposures it is drawn from. 



SCIENTIFIC FIRE-RATING 189 

In order to get this broad basis, several companies, 
indeed many companies, will need to pool their statistics. 
This has been a stumbling-block in the past, but is not 
likely to be such in the future, when the advantages and 
the safety of such procedure are fully understood. I well 
remember the expression of disgust with which the sug- 
gestion was received by a friend of mine, high in the fire 
insurance world, more than ten years ago. The feeling 
was at the time that such a thing could be accomplished 
only by so exposing the experience of the individual 
company, that all its underwriting mistakes would be an 
open book to its rivals. In addition to this humiliation, 
the managers also saw the possibility that their under- 
writing successes would give such indications to then- 
rivals, that the advantage which they had enjoyed would 
soon be lost. 

Of course, the statistics of the experiences of the com- 
panies could be pooled in a manner to involve just such 
disadvantages. Each company might digest its totals 
by classes and give in the results, exposing its own mistakes 
and successes. But if it were done in this way, in addition 
to this objection, there would be the further objection that 
the grouping would have to be wholly predetermined, the 
data could not be rearranged as occasion seemed to de- 
mand, and the persons charged with responsibility for 
the results could not know certainly that the grouping 
had been made in precisely the form desired, so that their 
conclusions were drawn from just the facts they assumed 
to be true. The experiences of life insurance companies 
could have been collected in a similar manner to make 
mortality tables; but they never have been, and few actu- 
aries would be willing to assume responsibility for the 
result, if they were. The form in which the material is 
collected is, instead, in individual risk histories on cards. 
And, as soon as the cards come in, they lose their identity 
so far as the company is concerned, and, in any event, 
they are not combined so as to show to anybody what 



190 YALE READINGS IN INSURANCE 

that company's individual experience has been. Of 
course, in collecting the data for the pool, a company may 
and, indeed, should put the same together for its own 
guidance and advice. But it will not be known to other 
companies and, moreover, will be of greater value to the 
company itself, when it can compare its own experience 
with the experience of all. The task of reporting this 
mass to a central body in such a manner may seem gigan- 
tic, but it is really no more labor than to digest the data 
before sending it in. It is better and more economical to 
have the sorting done by one set of clerks, and under the 
supervision of the committee in charge. The same indi- 
vidual cards, too, are likely in such case to be employed 
successively for different purposes, falling into new groups 
one after another until all the information which they 
give is extracted. 

Mention has already been made of the desirability of 
having the material fluid, so to speak, so that it may be 
grouped into new and unexpected classifications, instead 
of being required to fall into predetermined classes. All 
fire insurance men have preconceptions as to what the 
statistics, when thus brought together, will demonstrate. 
In order to deal with the subject at all, it will be necessary 
for the committee in charge to recognize these precon- 
ceptions, as a means of determining the first forms of 
classification. But the first grouping, however skilfully 
made, is never likely to prove wholly correct. Many of 
the preconceptions are sure to be erroneous; and, when 
this is shown, the material should be in such form that new 
groupings, suggested by the facts as they develop, may be 
adopted. 

There is one sort of hazard which deserves to be put 
to one side for separate consideration; that is the con- 
flagration hazard. Two things appear to be clear about 
it from the outset, viz., first, that to get any sort of meas- 
urement for it, many apparently unlike hazards in all 
other regards must be grouped together and, second, that 



SCIENTIFIC FIRE-RATING 191 

in order to get an average, periods much longer than one 
year must be employed. When the method of properly 
measuring this hazard has been arrived at, it will also 
involve the necessity for recognizing, that reserves to 
cover it must take into account a period of much more 
than one year. Then the truth will come to light, that 
much of the funds which are now held as surplus, are really 
reserves against this conflagration hazard, and that it is 
wisdom to accumulate such and folly to fail to do so. 
The liability on this account reminds one of what the 
actuaries call " suspended mortality" in life insurance. 
This means that the company which assumes that, because 
at younger ages it shows a great saving on the mortality 
estimates, the same salvage will apply straight through, 
forgets that the men who failed to die at forty, are merely 
reserved to make a larger number of deaths at the higher 
ages. Thus conflagrations are not expected every year, 
and such portion of the premium as represents this hazard 
is not released when the year has passed, unless the risk 
is wholly off the books. 

This reference calls to mind the safety fund law of New 
York, which is, in a way, a recognition of this necessity 
for a special conflagration reserve. Its defect seems to 
me to be that instead of being a provision directly to 
cover the conflagration risk, it is only indirectly so, since 
it acts as a special protection of other policy-holders 
against their reserve values being swallowed up by the 
conflagration. 

The inquiry is surely pertinent, in view of the trouble 
and expense which such an undertaking as this investiga- 
tion would occasion, what is the good of the ratios any- 
how? Many consider that rates are made by competition, 
and that the idea of securing uniform rates without 
combination is a foolish dream. And they reason that, 
since combination is necessary in order to sustain rates, 
and since by means of combination it is already demon- 
strated that they can be kept high enough to pay a good 



192 YALE READINGS IN INSURANCE 

profit, the expense and labor to ascertain costs would be 
wasted. 

Much of this contention is justified. Too much must 
not be expected of the mere ascertainment of the costs. 
In manufactures, for instance, the cost is usually perfectly- 
well known to all parties. Yet undue competition has 
often brought about absolutely ruinous conditions, and 
the excuse which is most frequently offered for trusts and 
combinations, is the practical impossibility of carrying 
on the business at all under free competition. Yet it is 
even worse to compete without knowing what you are 
losing when a certain price is made. In these very periods 
of cut-throat competition, the manufacturer who has 
most completely in hand the information about costs, 
is enabled to inflict far worse injuries than he receives, 
while his adversary strikes in the dark and often injures 
himself instead of his antagonist. 

Surely it is irrational to carry on a business in such a 
manner. Moreover, the fact that it is thus carried on, 
cannot be hidden from others and it creates unusual 
resistance to rating schedules. Men resent changes in 
their rates, anyhow, but yet more do they fight against 
them when they can set their judgment up against the 
underwriter, knowing that the latter cannot assign a 
reason for his opinion, and is, in fact, in doubt whether 
the rate should be so much or so much. Well do I per- 
sonally recall the effect of a rating upon the property 
owners in the country town where I was brought up — a 
rating which involved doubling many premiums. It was 
not comprehensible to the business men that these risks 
were good at the old rates the day before, but required 
the new on that day. It takes good grounds to justify 
such to the mind of the average man. And the resent- 
ment and ill-feeling occasioned in this manner and fomented 
by the surmise that the rate-makers do not know that the 
new rates are correct, result in movements against the 
companies, in laws against combinations and the like. 



SCIENTIFIC FIRE-RATING 193 

But it is not merely as a means to avoid this sort of 
prejudice that accurate information as to costs would be 
useful. The fact that rates were thus determined would 
gain the good will of many. This information in simple 
form, would satisfy men that their interests were guarded 
in the working out of these problems, and that care was 
taken to make rates in proportion to the value of the pro- 
tection. In my own short experience as a fire insurance 
man, I remember that a little talk about the underlying 
principles of insurance more than once disarmed prejudice. 
If these fundamental principles were strictly regarded, as 
they would be under a system of scientific rating, it is 
difficult to see how a business man could offer a fair excuse 
for objecting to pay what experience showed to be his just 
share of the losses and expenses of the business. 

If the tariff associations were abandoned, it is true that 
the mere fact that the costs had been accurately ascer- 
tained might not restrain undue competition. It would, 
however, be likely to have a steadying effect upon rates 
and might serve ordinarily to confine the competition 
within narrow limits. Such, in any event, has been the 
effect in life insurance, so far as the regular companies 
are concerned. Moreover, since the purchaser of fire 
insurance buys a promise, instead of a commodity, rates 
that are cut too much might, if the fact could be shown, 
create such fear of the security of the company as would 
cure the evil or keep it within bounds. It would be foolish 
to say that this effect can be depended upon, for we have 
the fact to face that for many years assessment life in- 
surance has been liberally patronized, although charging 
rates so insufficient that the safety of the insurance was 
imperiled. You also have known many instances where 
doubtful fire insurance has readily been accepted in order 
to save a little on the premiums. While this is true, how- 
ever, the fact that most of the fire insurance is in companies 
that decline to meet the competition of notoriously unsafe 
concerns, shows that most business men do value security 



194 YALE READINGS IN INSURANCE 

above a saving in rates. When the facts concerning the 
cost of fire insurance have come to light as to each classi- 
fication, companies that for a time seek to do business at 
rates that are below cost can be made to appear notori- 
ously unsafe very readily, because they really would be 
so. Such would rarely be backed by substantial capital 
and would not be feared. 

Another most important advantage that should flow 
from this determination of the costs of fire insurance is 
that it ought to contribute very much to the solution 
of the commission problem. It is well known that the 
difficulties concerning commissions had their origin in 
the fact that certain classes of hazards were known to be 
more profitable than others, and this, not because of the 
superior skill of one company over another in selecting 
risks of that class, but because of the fact that the rates 
were higher in proportion to the hazard. These classes 
came to be known as preferred, and, while the Western 
Union companies were doing nothing to show their pref- 
erence for them, the non-union companies were emphasizing 
their choice by offering much larger commissions for pre- 
ferred risks. With the costs accurately ascertained, the 
gross premiums may be made to accord with the net, with 
the same margin for expenses and profits, or with a different 
margin, as is thought wisest, and level or graded commis- 
sions will be provided for, precisely as the companies 
prefer. Moreover, it will be in their power to make any 
class of risks more or less profitable by changing the margin, 
and thus to take it out of the possibilities that larger 
commissions shall be offered than all are able and willing 
to pay. 

Reference has already been made to the steadying effect 
which the mere fact that the costs have been ascertained, 
will be likely to have upon rates. This steadying effect, 
however, would be greatly increased if this cost were made 
the basis of reinsurance reserves as reported to the depart- 
ments instead of such reserves being based upon gross 



SCIENTIFIC FIRE-RATING 195 

premiums as at present. By " gross premiums" I mean 
the actual premium receipts for the year, "net" in the sense 
that cancellations and the like have been deducted. At 
the present time a company gets off with a smaller reserve 
charge, the more insufficient its premiums have been. 
Thus, if it accepts business for half rates, its reserves are 
half as much as if its rates were full. In this manner 
insolvency is sometimes concealed for a time and the state's 
certificate of solvency becomes vain. In a recent annual 
report of the Massachusetts department, public attention 
was called to the fact that by means of reinsurance an 
insolvent company might transfer its business to a con- 
cern that was not more solvent in point of fact, but that 
made an appearance of solvency, if charged under the rules 
with a reserve liability for only one-half the reinsurance 
premium, however inadequate that might be. 

The question is pertinent whether the cost schedules 
would be likely to be accepted by state legislatures as 
standards of solvency. As to this nobody can surely say; 
but we do know that a scientific reserve was adopted as to 
life insurance companies and that the presence of this 
legal standard has had a wonderful steadying influence 
upon life insurance premiums in the regular companies. 

In this connection, it is worthy of remark that the legal 
reserve rules as to the valuation of life policies have not 
brought about absolute uniformity as to life insurance 
premiums. There are many variations; but these are kept 
within reasonably narrow limits. In consequence, there 
is not much complaint about these differences. It must 
be conceded, though, that the problem in fire insurance 
is different; for in life insurance considerations as to the 
profit-earning power of the various companies influence 
the choices, as also do personal preferences and especial 
confidence in particular institutions. In fire insurance, 
on the contrary, so long as the company is safe, there is 
never much choice, and so the cheapest bidder gets the 
risk as a mere matter of business. But, on the other 



196 YALE READINGS IN INSURANCE 

hand, it does not follow that because in life insurance an 
equilibrium of rates has not been the result of scientific 
reserve systems, it would fail to be the consequence of the 
adoption of such a system of fire insurance reserves. 

It is possible, too, that the companies might turn to 
the very device for assuring that they can collect ample 
premiums that has long been employed by life insurance 
companies, viz., to make the policies participating. This 
was tried in fire insurance many years ago, but had little 
then to recommend it. Now, however, the competition 
is hard and close and it is possible that often the insured 
would attest his confidence that the rates should be materi- 
ally lower by being willing to pay the higher rate, provided 
the insurance was written, so that his policy would par- 
ticipate in the profits. Life insurance companies have by 
this means been enabled to collect one-fourth or more over 
the stock or non-participating rates, every cent of which 
extra premium is available if needed, to pay losses or 
expenses. In fire insurance, of course, great care would 
need to be exercised, and if this excess were subject to the 
payment of commissions, there might be no possibility of 
making the plan work. But, operated with caution, it 
might work all right, giving the insured lower actual cost, 
while assuring the company against the possibility of 
coming out behind. This may prove to be the ultimate 
solution of the problem of providing flexible premiums, in 
spite of the fixed cost ratios which investigation would 
discover. 

Another benefit that might flow from the establishment 
of a joint statistical bureau is that, gradually by a process 
of extension, the indemnity furnished by fire insurance 
companies might be widened to cover many risks which 
are now tabooed. Thus the hazard of loss by explosion 
might be investigated and, instead of excluding this risk 
of property loss, it might be included. Insurance is more 
valuable, the more inclusive it is; and, where the risk of 
loss from one cause is slight, it can hardly be covered 



SCIENTIFIC FIRE-RATING 197 

except in connection with other hazards to the same 
property. In a like manner, the risk of the collapse of 
a building might be covered. As to the subject matter 
of insurance, there might also be the extension to cover 
profits which a business man loses through the stoppage 
of his business when his property is destroyed. Remun- 
eration for such lost profits is nowadays strictly ruled out 
by all companies; if this could be covered safely, it would 
be well. In London, according to the press reports, the 
need for such insurance has become so pronounced, that 
a separate company has been organized to furnish it. 

It has been argued that the ratios which would be 
arrived at, would be vitiated by the fact that insurances 
for full value and insurances for only a part of the value 
would be grouped together. It is, to be sure, well known 
that both overinsurance and underinsurance have their 
perils for the company. Thus overinsurance tends to 
induce incendiarism, and underinsurance results in much 
protection being furnished for a small premium. Since 
most losses are partial and, indeed, for small parts of the 
value, a policy for one-half the value or less often calls 
for as large a payment on the part of the companies as if 
it had been for full insurance. 

We have already seen that there can be no claim that 
the classification is perfect and, in fact, that a perfect 
classification would be useless. In this regard, it must be 
conceded, I am confident, that the classification cannot 
be homogeneous. The cost as ascertained, will be higher, 
by some percentage not yet measurable, than it should be 
when full but not excessive insurance is carried, and lower 
than when a very small part of the value is insured or 
when excessive insurance is taken. But the cost ratios 
will represent the average, insurance being taken as men 
desire to take it, some too much, some too little, many 
approximately the right amount. These are, perhaps, 
in the present stage of the business and of our knowledge 
the most useful ratios we could have. Deductions from 



198 YALE READINGS IN INSURANCE 

rates, based upon such costs, might be allowed when full 
insurance is taken, and this is doubtless the best form for 
such discrimination to take — much preferable to fining 
the insured for not carrying full insurance and less likely 
to arouse resentment and cause retaliation in the form of 
adverse legislation. 

It has been asked again and again, what effect these 
ratios would be likely to have upon the schedule system 
which has been so widely introduced and which unques- 
tionably has served a very good purpose. It must be 
replied that nobody knows in advance. If anybody did 
know just what the ascertainment of these ratios will 
reveal and could prove to others that he knew it, much 
expense and trouble might be spared us. For myself, I 
have been interested in the Universal Mercantile Schedule 
from the moment I heard of the idea, and I procured a 
copy as soon as I could. It seemed to me then and it 
seems to me now both a step toward more intelligent 
treatment of the question and also an absolutely necessary 
precursor of scientific rating, showing the general methods 
which must be pursued and also the necessity for cost 
ratios, based upon actual experience, by means of which 
to construct a schedule, perfect and reliable. It has 
seemed to me to be a sort of John the Baptist crying in 
the wilderness, or a schoolmaster to bring us to Christ. 
There can be no doubt that the results of an investigation 
will indicate the desirability of schedule rating and nobody, 
of course, will welcome more heartily the changes in the 
present schedules, no matter how radical and sweeping, 
if correct and founded upon substantiated facts, than the 
able and ingenious gentlemen to whose prevision of the 
coming conditions and to whose indefatigable labors we 
owe the present schedule. Scientific rating comes not to 
destroy the law nor the "profits," let us hope, but to ful- 
fil. 

Let us see what the investigation might be expected to 
yield Jn the way of information that would throw light 



SCIENTIFIC FIRE-RATING 199 

upon the schedule. First of all, it ought to be able to 
determine for each class the loss ratios from various as- 
signed causes, differentiating also by comparing smaller 
groups, as to risks with and without certain improvements 
and fire-fighting appliances. By this process a close esti- 
mate, first, of the residual, unverified cost, and then of the 
costs because of deficiencies, etc., might be made. Surely 
many things, that in the opinions, even of persons who are 
most favorable to scientific rate-making must yet remain 
subjects for empirical modifications of the rates, are likely 
during such an investigation, if properly conducted, to 
take definite form and in some cases to yield thoroughly 
reliable ratios for extra charges or allowances. 

Naturally the investigation, if attempted, would cover 
separate ratios for various territorial divisions and also 
ratios for different periods of time. These, together with 
the reports as to ratios of loss from different causes of 
fire, might solve the question which has troubled so many 
underwriters, whether there really is something in mere 
locality which affects the fire ratios favorably or unfavor- 
ably. The bearing of this investigation upon the Uni- 
versal Mercantile Schedule, just because it claims to be 
universal, is manifest. 

Proper classifications will also enable the committee 
in charge of such an investigation to determine the in- 
fluence upon the fire loss ratios, of single and multiple 
occupancies, of various sorts of occupancies, of exposures 
of every sort and nature. Such investigations will be 
intricate and it will greatly facilitate them if the informa- 
tion comes on cards, in the manner already indicated, so 
that they may be shuffled about and grouped again and 
again for different purposes. It ought to be possible to 
extract all the information that will be useful before the 
card is cast aside; and, in order to do this, the amount of 
information contained upon each card will not need to be 
multifarious. Comparatively simple groupings only should 
be called for. 



200 YALE READINGS IN INSURANCE 

The labor of conducting such an investigation will be 
very great because of the enormous mass of material to be 
digested and because of the number of classifications that 
will be needed. But, while arduous, the work will not be 
difficult and will in the end prove simple and easy. None 
of the intricate and puzzling mathematical problems which 
actuaries have to deal with, when handling life insurance 
statistics, will here be encountered. A perfectly clear 
head, a firm grasp upon the objects to be attained and un- 
failing insight into the methods by which the same may 
be secured, will help over the worst difficulties in classify- 
ing such a mass and drawing proper deductions from its 
statistics. The task would not be regarded formidable by 
skilled statisticians, except on the ground of the amount 
of data, and even that is not great when compared with 
the statistics which are often treated in connection with 
a national census. There is certainly nothing insuperable 
in the difficulties of the task; and the work ought not to 
involve expense at all comparable to the probable value 
of the results. 

Hi 

It is probable that from the earliest days of fire insur- 
ance the companies have maintained tabulations of their 
experience with grouped hazards. These lists have slowly 
expanded in differing degrees, though some have reached 
a far more advanced stage of differentiation than others. 
In the primitive days when each company not only had 
the privilege of making its own rates, but from lack of 
association was compelled to do so, when competition was 
so small that it could make rates which insured a wide 
margin of profit, these lists served as a crude scale — ■ 
something like the farmer's fence-rail and stone — for the 

x By A. F. Dean. Reprinted from pages 47-60, 73-80, of "Fire 
Rating as a Science;" Chicago, J. M. Murphy. 1901. 



SCIENTIFIC FIRE-RATING 201 

quantitative measurement of class hazards in their sequen- 
tial relations as indicated by individual experience; but 
in these days of competition, when a company is compelled 
to keep in the swim by carrying all classes of property, of 
every grade of desirability, in deference to the wishes of 
more and more exacting agents, these individual classi- 
fication lists have fallen into a sort of innocuous desuetude, 
surviving like the coccyx and vermiform appendix, the 
remains of organs that served their purpose during some 
earlier stage of evolution. Kept up at a great expenditure 
of time and money, and carefully guarded among the 
secret and sacred archives of each company, it would 
be difficult to determine what intelligent end these lists 
serve at the present time that would not be as well served 
by a Roman soothsayer's chicken-gizzard. Their utility 
as a practical guide in determining the relative profitable- 
ness of classes may be inferred from the following tabula- 
tion of the comparative experience shown by a number 
of these individual lists for the same five-year period. 
The figures in the column marked "low" show the loss 
ratio of the company having the most favorable experience, 
and the figures in the column marked "high" show the 
loss ratio of the company having the most unfavorable 
experience, with each of the classes designated by numbers. 
The column marked "combined" shows the combined loss 
ratio of all the companies on the same class for the same 
period: 



202 



YALE READINGS IN INSURANCE 



Class No. 


Loss Ratios Shown by 
Individual Experience 


Loss Ratios 
Shown by 




Low 


High 


Combined 
Experience 


1 


.00 
.10 
.00 
.06 
.18 
.03 
.05 
.19 
.10 
.34 
.12 
.16 
.21 
.18 
.02 
.01 
.08 
.43 
.19 
.04 
.33 
.29 
.16 
.29 
.18 
.13 
.30 
.30 
.22 
.17 
.03 
.10 
.11 


1.11 
2.13 
1.31 
1.88 
1.69 

.92 

.91 
1.05 
1.37 
1.73 
1.32 
1.79 
1.35 
1.29 

.78 
2.11 
2.46 
4.95 
1.11 
1.02 
1.50 
1.05 
1.04 
1.76 
1.03 

.86 
2.64 
1.65 
4.46 

.67 
2.00 
2.16 
1.77 


53 


2 


54 


3 


43 


4 


66 


5 


50 


6 


60 


7 


60 


8 


67 


9 


65 


10 


58 


11 


.74 


12 


.63 


13 


.44 


14 


.77 


15 


.25 


16 


1.21 


17 


.53 


18 


.97 


19 


.72 


20 


43 


21 


.61 


22 


.57 


23 


.50 


24 


.62 


25 


.46 


26 


.52 


27 , 


.64 


28 


.67 


29 


.97 


30 


.43 


31 


.90 


32 


.81 


33 


.47 







SCIENTIFIC FIRE-RATING 203 

These classes, selected from the lists at random, show 
that with each and every class one company had a very 
low loss ratio, while another company had a loss ratio that 
would bring swift ruin had it not had a more favorable 
experience with other classes. A mere glance down the 
two columns marked "low" and "high "will show the utter 
worthlessness of the separate experience of a single com- 
pany as a criterion to the average loss ratio of each class, 
while on the contrary, a comparison of these individual 
experiences with the column marked "combined" shows 
that there is an established mean which, if known, would 
constitute a reliable standard for determining adequate 
class rates. 

But further examination into these individual lists 
reveals an inaccuracy and wastefulness of method which 
would destroy their reliability, even were the experience 
of each company broad enough to constitute a reliable 
criterion. At a rough estimate, one hundred and fifty 
companies maintain these classification lists, at a heavy 
expense for clerical work. During a single year these 
companies receive, let us say, a total of five million daily 
reports of policies issued, each of which contains a ver- 
batim copy of the written portion of a policy. The neces- 
sity for determining the proper class of each daily report 
received requires that it be carefully scanned and its class 
number noted upon it, in order that it may be properly 
entered upon the records. This work is necessarily done 
in a hurried manner by a clerk or examiner who cannot 
possibly give much time or thought to each daily report. 
In many cases it is impossible to tell from the written 
description how the risk should be classed. In thousands 
of cases, from fifty to one hundred companies receive 
daily reports covering the same property which, in the 
hurry of current necessity, are entered haphazard in any 
one of a dozen different classes on the ledgers of the several 
companies, and the same work thus manifolded from fifty 
to one hundred times creates a corresponding liability to 



204 



YALE READINGS IN INSURANCE 



error. A loss on a single risk, wrongly classified destroys 
the value of the records of two classes. 1 

Another important element of unreliability in these 
individual lists results from the constant fluctuation of 
rates. The lists contain the total premiums received 
and the losses paid on each class, a comparison of which 
is supposed to reveal the loss ratio of the class. This loss 
ratio, however, is only useful in determining the adequacy 
of rates; and with rates constantly changing, the standard 
ceases to be a standard, and tabulated experience without 
a standard of comparison is worthless. 

Let us take for illustration the rates on the dwelling 
class, which have declined throughout a large portion of 
the Northwest from 25 to 35 per cent, during the period 
named, assuming the premiums and losses on the same 
amount at risk to have been as follows: 



Year 


Premiums 


Losses 


1892 


$100,000 
90,000 
80,000 
75,000 
66,000 


$50,000 


1893 


40,000 


1894 


45,000 


1895 


60,000 


1896 




50,000 








Total . . 


$411,000 


$245,000 



Total loss ratio, 60 per cent. 

Assuming the normal loss ratio of the class to be 55 per 
cent., the average loss of 60 per cent, shown by the above 
figures would indicate that dwellings ought to be advanced 
about 5 per cent., but if we compare the last year's pre- 
miums with the losses of that year, we find the loss ratio 

1 In the office of a prominent insurance company a five-thousand 
dollar line was recently classified as a printing-office. When a loss 
occurred, it was accidentally discovered that the risk belonged to an 
entirely different class. This single error affected the company's 
loss ratio with the one class twenty-five per cent., and with the other 
nearly one hundred per cent. 



SCIENTIFIC FIRE-RATING 205 

to be about 76 per cent., and that dwellings should be 
advanced about 21 per cent, from current rates, hence, any 
attempt to fix rates from the figures shown would be met 
with the question, From what point shall rates be modified 
— from the highest point or the lowest point, or from some 
intermediate point? In other words, the value of the 
figures for quantitative reasoning is destroyed by the 
vacillation of one of the quantities necessary to the com- 
parison. 

Another element of unreliability in the lists of individual 
companies lies in the non-concurrent grouping of classes. 
In this respect, probably no two agree ; and in the constant 
evolution of hazards (in the absence of any common 
source of information), lists are in constant course of 
change, as determined by the judgment of classification 
clerks under urgent necessity for immediate action. 

In view of the uncertainty of grouping, the uncertainty 
whether a risk, even when properly grouped, will get into 
the group to which it belongs, and the destruction of the 
standard of measurement caused by rate fluctuations, 
the individual classification list as a basis for quantitative 
measurement is by several degrees more crude and primi- 
tive than the farmer's fence-rail and stone; but as the 
latter contained the germ which has evolved into the 
chemist's scales which will weigh an eyelash, these individ- 
ual company classification lists constitute the embryo 
which must ultimately evolve into a logical, uniform, and 
combined system for the quantitative measurement of 
sequential relations. 

Ordinary candor compels the admission that the classi- 
fication of coexistent relations found in our present tariff 
system constitutes the only feature of fire insurance which 
gives it the slightest right to claim that it is not a world- 
wide game of guess. The same degree of candor will not 
permit us to deny that, as a practical guide in accepting, 
or rating risks, company classification lists in severalty 
are worse than useless, because in their limited way they 



206 YALE READINGS IN INSURANCE 

are misleading. It should be borne in mind, however, 
that these lists show a distinctly different phase of classi- 
fication from that found in our tariff system, for the 
reason that they constitute the embryo of a system for 
establishing sequential relations. 

A careful study of these lists shows that, with all their 
imperfections, they contain no fault that is not easily 
and inexpensively remediable. To coordinate these lists 
into a uniform grouping of classes and to combine the in- 
dividual experience of each company into grand aggregates, 
showing the annual experience of all companies with each 
class, would require neither violation of scientific pro- 
cedure, nor departure from methods suggested rather 
than established through these individual classification 
lists. There can be no verification of sequential relations 
(which are the combined effect of annual fire destruction 
and the coexistent relations established through basis 
tariffs) except through uniform and combined classifica- 
tion. This is the statistical basis upon which fire-rating 
as a science of sequential measurement must rest. 

It would seem to be a reflection upon the intelligence 
and honesty of the fire underwriting community that dur- 
ing the past quarter of a century every effort to bring 
about uniform and combined classification for the purpose 
of establishing intelligent sequential relations should have 
been thwarted by a silent opposition which has seemingly 
disdained to argue the question. It has been charged 
that this opposition emanates from a belief on the part 
of the management of some of the larger companies that, 
under existing conditions, these companies possess advan- 
tages which would be lost by the revelation of class aver- 
ages. It is hard to believe, however, that the intelligence 
which has brought these companies to the front could be 
blind to the compensating advantages which would accrue 
from the placing of fire insurance among the recognized 
and legitimate branches of commercial activity. At most, 
combined classification would simply establish averages 



SCIENTIFIC FIRE-RATING 207 

derived from the experience of all. It would not unseat 
common sense, nor dethrone the individual judgment, 
which itself has been well defined as a finer and more 
discriminating classification. The establishment of these 
averages would leave even greater advantages to under- 
writing ability, capital, and established reputation than 
under existing conditions, which enable unscrupulous and 
plunging methods not only to upset the possibility of 
legitimate underwriting, but not infrequently to win a 
greater financial success. Greater disparities are found 
in the comparative success of banks, merchants, and 
manufacturers, than among fire insurance companies, 
because legitimate enterprise gives ample scope for the 
qualities necessary for success. Without doubt, selfish- 
ness, inertia, and ignorance are largely responsible for the 
failure of fire insurance to realize the benefits of combined 
classification, though it would be as illogical to censure 
the motives of the fire underwriting community generally 
as to censure the community at large for its inertia in 
many important matters of reform which do not admit 
of logical discussion. " Direct complicity with human 
affairs is not infrequently a hindrance to the scientific 
investigation of phenomena. Even the axioms of geome- 
try would be disputed or ignored if men's passions or 
interests were concerned with them." 

The English-speaking peoples adhere to an orthography 
that is the despair and wonder of the world. We boast 
of our decimal currency, but refuse to adopt a decimal 
system of weights and measures, while the complacent 
Briton refuses to adopt the decimal system for either 
his currency, weights, or measures. During the slow 
evolution of single-entry and then of double-entry book- 
keeping, the English government stubbornly adhered to 
a primitive system of keeping accounts by cutting notches 
in sticks. It would probably be using this system yet had 
not a conflagration in 1884 burned up all its exchequer 
tallies. Inertia hath its uses, however, "The man who 



208 YALE READINGS IN INSURANCE 

will not look at the new moon, out of respect to that 
ancient institution, the old moon," was not created in 
vain. Perhaps it is fortunate that combined classifica- 
tion was not started too soon, for a false start might have 
brought the system into disrepute, and it is always easier 
to start anew than to undo and patch up a system full of 
errors. To-day, however, fire insurance is in the position 
of the British government when its exchequer tallies were 
burned. Many states have destroyed our rating system, 
such as it is, by anticompact laws; many others are threat- 
ening to do so, and a new start is inevitable. If we start 
along lines that cannot be justified by scientific reasoning 
at every point, so much the worse for us, for we will ulti- 
mately be compelled to tear down our system and rebuild 
from the foundation. 



CHAPTER X 

TABULAR RATING IN GREAT BRITAIN 1 

The primary object of a scale of rates, whether they 
are laid down in a tariff or have arisen out of the daily 
experience of fire insurance managers, is to provide a 
fund which will meet the losses from fire which occur, 
will provide for the expenses of administration and 
for the building up of reserves, and will then leave 
over a sufficient margin for the payment of dividends 
to proprietors. Fire insurance companies are not 
philanthropic institutions, and it is as much in the 
interest of the public as of shareholders that they 
should be abundantly strong and yield sufficient 
profits to attract the necessary capital and also to 
preserve a high level of credit. All insurance com- 
panies live by credit. They are paid in advance for 
the services which they render, and credit is as much 
necessary to them as it is to a bank. 

While, however, the primary object of rating is to 
secure sufficient premiums to meet the financial re- 

1 From F. Harcourt Kitchin's "Principles and Finance of Fire 
Insurance," London, Effingham Wilson, 1904, pp. 162-181. 

Doubtless a weighty reason for the lack of success of the agitation for 
combined classification as a basis of fire rating in the United States has 
been the comprehensive character of the proposal. Companies would 
be less reluctant to pool their experience with reference to particular 
risks concerning which more accurate knowledge is specially needed. 
Thus combined experience might be gradually extended as its merits 
became more manifest. The British method of gradual reform, 
beginning where reform is most urgently required, may be illogical 
and unsystematic, but it is very practical. W. H. P. 

209 



210 YALE READINGS IN INSURANCE 

quirements of the companies, there is a secondary and, 
from the public point of view, an even more important 
object c This is to keep down the severity of fires and 
to minimize the losses from this cause by which a 
community suffers. Every loss by fire is a dead loss. 
There is no return possible for the destruction of 
property. All that fire insurance companies do is to 
produce fresh capital in the place of that which has 
been lost. It is therefore in the interest of the public 
that fire losses should be reduced in every possible 
way, and this interest is fully recognized by the pro- 
vision of Building Acts and fire brigades administered 
and supported by local authorities. But although 
fire insurance companies have no direct power to 
compel the use of the best appliances and the best 
materials for construction, and thus to prevent fires, 
they have an immense indirect power of penalizing 
those who will not make use of the best materials and 
means of construction and will not adopt the appli- 
ances which experience has shown to be essential if 
the fire hazard is to be minimized. I hold no brief 
for a tariff organization — in fact I have expressed 
my view plainly that the competition of non-tariff 
companies and of private underwriters is wholesome 
as tending to prevent tariff offices from becoming 
hidebound — but it must be allowed that full and 
systematic pressure in the direction of fire prevention 
can hardly be depended upon unless at least the ma- 
jority of the fire insurance companies are pledged to 
stand together and insist upon penalizing those owners 
of property who will not conform with their require- 
ments for the prevention of fires. In marine insur- 
ance, where there is no general tariff and we see free 
competition between companies and Lloyd's and be- 
tween insurance markets in London, Liverpool, Paris, 
New York and other centers, the difficulty as regards 
construction and appliances is to a large extent got 



TABULAR RATING IN GREAT BRITAIN 211 

over. Ships are built under the superintendence of 
the surveyors of Lloyd's Register of British and For- 
eign Shipping — which is quite distinct from the 
Society of Lloyd's, though underwriters are repre- 
sented upon its committee equally with ship-owners 
— or of the surveyors employed by the Bureau Veritas 
and other similar foreign organizations. Vessels are 
classified by these bodies and the works of reference 
published under their authority contain the particu- 
lars which marine underwriters find it necessary to 
know. If buildings on land could be surveyed and 
classified on some such system, much of the work of 
the tariff officers would be unnecessary and the method 
of differential rating would be greatly simplified. But 
in practice it is quite impossible to apply on land a 
system which is easy enough to apply as regards ships, 
and it so happens that the fire offices by means of 
tariff rules and differential rates have to do for them- 
selves much of the classification which in marine 
insurance is done, and, from the nature of the case, 
done more efficiently by Lloyd's Register and kindred 
bodies. I would ask my readers to keep this parallel 
in their minds and to consider a tariff from two points , 
of view : (1) that of providing a remunerative premium, 
and (2) that of providing a means of classifying or 
grading risks according to hazard and a means of 
making property owners pay in proportion to the fire 
risks which are actually incurred. 

There is no general and scientific system of rating 
risks in this country which can be compared with 
that attempted under the American Universal Sched- 
ule, but I shall be able to show that the tariffs here 
are drawn up on a method which fulfils an important 
public service, while at the same time there is sufficient 
competition among the different classes of insurance 
companies represented on the Fire Offices' Committee 
to prevent rates being raised unreasonably high. If 



212 YALE READINGS IN INSURANCE 

all the companies did foreign as well as home business 
there might be a danger that the losses on foreign 
risks might be recouped by too high rates on home 
business. But several companies of the highest stand- 
ing and influence do nothing but home business, and 
it is in their interest to see that the rates laid down are 
not more than are sufficient to provide for the losses, 
expenses, reserves and reasonable profits. In fact, the 
method under which the rates chargeable to a trade 
or a section of property owners dealt with under a 
tariff are determined is alone sufficient to show that 
each trade or division is looked at strictly on its own 
merits. 

If business in the books of any company is properly 
classified a fire manager can tell almost from day to 
day whether he is gaining or losing money on a par- 
ticular class of risks. A good manager will have all 
his insurances classified by trades, construction of 
buildings, towns, counties and agencies. He will have 
all the premiums and outgo entered under the various 
headings and keep also a watch on the causes of fires. 
By means of periodical returns from all his branch 
offices he will be able to maintain the closest watch 
over the whole business which is under his control. 
He can sort out profitable trades, in the fire insurance 
sense, from unprofitable ones, and can classify towns 
and counties of good reputation and readily distin- 
guish them from those which are insufficiently supplied 
with fire-extinguishing appliances or with efficient 
brigades. He can also quickly tell whether his agents 
and branch officials exercise proper care in satisfying 
themselves concerning the good faith of the persons 
who make proposals for insurance. It is, in fact, not 
too much to say that the materials exist, or could 
rapidly be compiled, sufficient to form the basis for 
as elaborate a classification and rating as that which 
was seen when the American Universal Schedule was 



TABULAR RATING IN GREAT BRITAIN 213 

framed. But at present very much of the classifica- 
tion is left to the individual fire insurance managers 
for the conduct of their own operations and does not 
form part of the common stock from which the tariff 
rates are framed. In fact, the tariff rates and sub- 
divisions to which I shall refer presently form rather 
a general outline than a complete picture, and leave 
much detail to be filled in by individual managers. 

We will now suppose that several fire offices, by 
means of the classification to which they have sub- 
jected their business, have discovered that a class of 
risks has proved unprofitable for some time. If the 
class is an important one and the unfavorable experi- 
ence appears to be at all general, then a prima facie 
case is made out for inquiry by the whole body of 
tariff offices represented on the Fire Offices' Com- 
mittee. Each company then prepares a detailed 
statement of its premium income for some years past 
and the fire losses on the class under investigation. 
No company sees the returns prepared by any other 
company, but they are all handed in, in the strictest 
confidence, to the chairman of the committee, who is 
at present a barrister and has no connection with 
any company. The chairman tabulates the returns 
and submits the results to the full committee, or in 
the first instance to a sub-committee, for considera- 
tion and report. If it be found from a careful ex- 
amination of the tabulated facts that a strong case 
has been made out for a revision of an existing tariff, 
or for the preparation of a new one, a change is ac- 
cordingly made. The revised rates, as soon as they 
have been accepted by all the members of the Fire 
Offices' Committee, come into operation. A pro- 
ceeding of this kind is a purely statistical operation 
based on past results over a wide area — the opera- 
tions of all the tariff companies — and there is nothing 
arbitrary about it. Some similar method is the only 



214 YALE READINGS IN INSURANCE 

possible one for arriving at an accurate premium for 
a particular risk, and it is much fairer to the public 
that rates should be based on a general experience 
than that they should be founded on the possibly 
exceptional experience of individual companies. I 
have for the moment spoken only of advances in pre- 
miums, but in practice the process of reductions goes 
on almost as much as that of advances. When rates 
are raised on one part of a class or trade it is frequently 
found possible to reduce them on another part and 
reductions are accordingly made. For example, when 
the tariff rates on farm dead stock were advanced 
some little time since, the rates on live stock were at 
the same time reduced. Quite recently the tariff rates 
on London mercantile risks have been reduced (Feb- 
ruary, 1904). Pressure is always going on towards 
the reduction of rates. Those offices which make a 
profit on a class of business and see their way to 
extend their operations have a strong objection to 
the rates being put up; they would probably, if the 
profit were considerable, prefer that a reduction should 
be made in order that more business of the kind might 
be obtained. It is commonly supposed among the 
public who pay premiums that fire insurance com- 
panies like high rates. But I have never found any 
basis for this belief. I have always found that low 
rates and a small fire hazard are vastly preferred to 
high rates and a high fire hazard. The best classes 
of business, the gilt-edged business which every fire 
manager likes to have on his books, pay the lowest 
premiums and the undesirable risks are generally 
subject to very high premiums. In practice it is 
found that the low-rated risks, at premiums from the 
minimum of Is. 6d. per cent, to about 3s. 6d. per cent, 
per annum, yield the highest degree of profit and are 
in every respect the most satisfactory. 

My readers are no doubt aware that fire insurance 



TABULAR RATING IN GREAT BRITAIN 215 

premiums on home business are very much lower than 
on ' most foreign business — the premiums in the 
United States and Canada are notoriously high and have 
recently been still further advanced. An examination 
of the annual returns of the insurance companies which 
transact nothing but home business shows a consider- 
ably higher average rate of profit to premium income 
than in the case of the great "international" com- 
panies with operations in all parts of the world. It 
has been suggested that the higher profit on home 
business is excessive and that home rates are kept up 
in order to pay for losses on foreign business. I do 
not think there is anything in this for several reasons. 
In the first place, it is unlikely that companies with 
home business only would consent to over-high rates, 
which would have the effect of choking off business, 
merely to please companies with foreign business. 
They would have no interest in doing so. Then it 
must be remembered that a large part of the most 
profitable home business is non-tariff and is subject 
only to the rule which fixes the minimum premium at 
Is. 6d. per cent. What is more, even if the whole 
profit on the low-rated home risks were given away, 
the amount of premium would be so small compared 
with that derived from the high-rated foreign risks as 
to make no appreciable difference. No, the truth is 
that low rates on risks of small hazard are able to yield 
a higher rate of profit than heavily rated risks simply 
because the rates are low. Let me explain. The 
phenomenon is not peculiar to fire insurance; it is 
seen just as prominently in marine insurance where 
gold bullion and specie insurance at Is. per cent, and 
even less are readily written in large lines. Suppose 
that it is found that the cost of insurance — losses, 
expenses and reserves — on a certain class of business 
is 2s. per cent, per annum. Now, if an office charges 
2s. 6d. per cent, it makes a 20 per cent, profit on 



216 YALE READINGS IN INSURANCE 

the premiums derived from this class and there is in 
practice little difference between a 2s. 6d. rate and 
one, say, of 2s. 3d. I mean that property owners 
who were charged 2s. 6d. would not probably press 
for a reduction to 2s. 3d. By charging 2s. 6d. the 
companies get a 20 per cent, profit, although the 
margin from which profits are derived is only 6d. per 
cent. Now consider a foreign risk, say in Canada, 
costing 30s. per cent, for losses, expenses and reserves. 
In order to make the profit of 20 per cent, on pre- 
miums just mentioned it would be necessary to charge 
property owners 37s. 6d. per cent., whereas the com- 
panies could make a 10 per cent, profit by charging 
33s. 4d. per cent. There is a good deal of difference 
between 33s. 4d. per cent, and 37s. 6d. per cent., and 
it may easily be not practical for insurance companies 
to charge as much as 37s. 6d. and have to be content 
with 33s. 4d. In the first case I mentioned the differ- 
ence between a 10 and a 20 per cent, profit on the 
premiums was little more than 3d. per cent., which 
the insured would hardly notice, and in the second 
case the difference was as much as 4s. 2d. per cent., 
which the insured would almost certainly notice a good 
deal. This example will make it clear that it is much 
easier to allow a wider margin of profit on a low-rated 
than on a high-rated risk, and, quite apart from any 
great variation from year to year in fire hazards, we 
should expect to find a higher rate of profit earned on 
low-rated risks than on those for which high premiums 
are charged. And that is just what we do find, not 
only in fire insurance but also in marine insurance. 

I have indicated the manner in which materials are 
collected and tariff rates based upon them. It has 
been the practice in this country not to form tariffs 
or to alter them unless sufficient cause was shown in 
each case, so that while there are fifty-seven classes 
of trades, towns and property subject to tariff rates 



TABULAR RATING IN GREAT BRITAIN 217 

and regulations (many of them with sub-divisions) 
the ground has not been covered in any systematic 
manner. 

The following is the list of tariffs: 



British Tariffs 



Belfast. 

Bermondsey Tanneries. 

Bleach and Dye Works (Ireland). 

Bonded Stores. 

Boot and Shoe Factories and 

Warehouses. 
Brick and Tile Works. 
Bristol. 

Cement Works. 
Clothing Factories. 
Cold Storage Warehouses. 
Corn and Rice Mills 
Cotton Mills. 
Crystal Palace. 
Distilleries (Scotland). 
Esparto. 

Farming Property. 
Flannel Factories (Wales). 
Flax and Jute Mills. 
Flax, etc., Warehouses (Scotland 

and Ireland). 
Fleetwood Dock Warehouses and 

Sheds. 
Floor Cloth Factories. 
Furniture Storing Warehouses. 
Glasgow and Paisley. 
Glass Works. 

Gloucester and Sharpness. 
Granaries. 
Great Grimsby. 
Hop Oasts. 
Hosiery Warehouses and Factories. 



Hull Timber Yards. 

Hull Warehouses. 

Lace Warehouses and Factories. 

Leeds Carriers' Warehouses. 

Leith and Granton. 

Liverpool Mercantile and Car- 
riers. 

London Manchester Warehouses. 

London Mercantile. 

Manchester Warehouses. 

Manchester Mercantile and Car- 
riers. 

Metal Workers (Scotland). 

Nitrates, etc. 

Oil Mills. 

Petroleum. 

Potteries. 

Rice Mills. 

Royal Albert Hall. 

Ships. 

Shirt Factories (Ireland). 

Shops. 

Sugar Refineries. 

Tanneries. 

Timber. 

Tyne, etc., Ports Mercantile. 

Wood Workers (Scotland). 

Woolen, etc., Warehouses. 

Woolen, Blanket and Flannel 
Mills, etc. 

Worsted Mills. 



The most striking omissions from the British method 
of tariff rating are two. First there is hardly any 
distinction between the fire hazard in various towns 



218 YALE READINGS IN INSURANCE 

— an essential part of the American Universal Sched- 
ule — and there is little distinction between the rates 
of premium on buildings and on the goods which they 
contain. I am speaking of tariff risks now, not of 
such things as private dwelling-houses and furniture, 
where a distinction of rates is drawn. In a few cases 
where certain towns have proved specially hazardous 
for various reasons, a tariff has been drawn up in regard 
to them. These towns are Belfast, Bristol, Great 
Grimsby, Glasgow and Paisley, Leith and Granton, 
and Gloucester and Sharpness. Special tariffs also 
relate to warehouses in Fleetwood, Hull, Leeds, Liver- 
pool, Manchester and Tyne ports, but all these tariffs 
are compiled ad hoc and not as part of a system cover- 
ing the whole country. In the United States under 
the schedule a locality where the fire loss was on 
average $5 per $1,000 of insurance per annum during 
five years is taken as a standard, and in localities where 
the annual fire loss shows a higher average an addi- 
tion to the rates of premium has been provided. The 
addition for each one dollar of loss in excess of five is 
20 per cent, of the minimum or key rate, an addition 
which amounts to 10 cents on each $100 of insurance, 
and this addition approximately maintains the equi- 
librium between the fire cost and rate of premium. 
The Standard City under the schedule must have a 
fire record for the preceding five years of not more 
than $5 per $1,000 of insurance, gravity waterworks 
with sufficient power to throw over five-story build- 
ings, water pipes of not less than six inches diameter 
in the dwelling section, and of eight inches in the 
mercantile section, a paid fire brigade, two steam 
fire engines to each square mile of compact area or 
one to each 10,000 of population up to 500,000, fire- 
alarm telegraph, efficient police, good and wide streets 
of which, say, 60 per cent, are seventy feet or more in 
width, a good building law well enforced and no out- 



TABULAR RATING IN GREAT BRITAIN 219 

lying exposures to cause sweeping fires. There are 
other provisions, but these are sufficient to show the 
class of city reckoned as standard. In the British 
tariff there is no such thing as a Standard City and no 
general computation of fire losses in different locali- 
ties. Individual offices do keep a very close watch on 
the hazardous character of the various towns and 
counties and pay attention to the efficiency of fire- 
extinguishing appliances within the areas, but there 
is no general application of the data thus acquired by 
all the offices combined except as regards the special 
and exceptional towns for which tariffs have been 
drawn up. 

When, however, we come to construction and 
consider the Standard Building, we then see that the 
fire offices under the British tariff have given much 
attention to this most important matter. Rules are 
laid down describing in detail the standard fire-resist- 
ing buildings to which the most favorable terms under 
the various tariffs apply. These rules deal with height 
and cubical contents, walls and partitions, flues, open- 
ings in walls, floors, roofs, protection of structural 
metal work, linings and ceilings, floor openings, shaft- 
ing through walls, pipes and electric conductors, and 
communicating compartments. As these rules are 
confidential — unnecessarily so, it would seem, as the 
more widely known they are the better for fire insur- 
ance and building generally — I must confine myself 
to the barest outline of them. Walls, external or 
party, must be of hard incombustible materials of not 
less than a prescribed thickness, and party walls must 
extend well above the roof of adjoining buildings. 
Flues must be fireproof, and floors, where not fire- 
proof, must conform to definite conditions. Roofs 
must be entirely of incombustible materials, and 
metal columns, girders and so on must be protected 
by a fireproof covering. Unprotected metal from its 



220 YALE READINGS IN INSURANCE 

liability to weaken and bend under heat and also to 
expand is a serious danger to buildings. Openings 
in walls and floors are regulated so as to minimize the 
setting up of strong draughts which would increase 
a fire. Speaking in general terms, a standard fire- 
resisting building under the British tariff is one which 
is very difficult to set on fire and one which will offer 
as few facilities to the progress of a fire as possible 
should one happen to occur. It is hardly too much 
to say that the fire offices, by giving favorable terms 
for construction designed expressly to prevent fires, 
have done more to reduce the fire danger in our cities 
than the efforts of legislators and municipal adminis- 
trators during several generations. In many respects 
the fire offices have set a standard which even now is 
tardily recognized by building legislation. 

By insisting upon a high standard of incombustible 
materials and means of construction if the lowest rates 
are to be obtained, fire insurance companies have done 
much to reduce the fire hazard, but by differential 
rating they have done still more. It may be con- 
tended that the penalizing of buildings and their 
contents when the best means are not taken to prevent 
fires has not gone far enough — the British tariff does 
not go so far as the American Universal Schedule — 
but it has probably gone as far and as fast as this 
conservative and illogical country can stand. 

Let us now consider a tariff and observe how the 
system of rating adopted in this country tends to 
give a bonus to those owners of property who will 
conform with the best conditions and penalizes those 
who will not. Under the method of discounts on 
normal rates, and additions to them, not only is the 
expense of meeting fire losses charged to property 
owners in some proportion to the risks incurred by 
them, but also the pressure of the high rates for haz- 
ardous construction or appliances powerfully tends to 



TABULAR RATING IN GREAT BRITAIN 221 

compel the adoption of recognized improvements. 
The central fact to be recognized is that fire offices 
by encouraging the reduction of fire hazards by means 
of reduced rates are not only benefiting themselves 
but also are conferring a very important benefit on 
the whole community. 

Take now the cotton mills tariff, England and Ire- 
land. The lowest normal rate applies to standard 
fire-resisting buildings, and other buildings are rated 
on a considerably higher scale. After setting out the 
minimum rates, there is laid down a list of additional 
rates in non-fireproof buildings for many things which 
are considered to increase the fire hazard. These are 
defective construction, height above four stories, floor 
openings other than those allowed, methods of light- 
ing and heating, night work, electro-motors and various 
processes in connection with the blowing of cotton 
previous to carding. These additions are made to 
buildings which do not come in a category of " fire- 
proof." Fireproof buildings or stories have a section 
to themselves, and the rates charged are much more 
favorable than those where additions have to be made 
on account of hazardous construction and appliances. 
In each of the sections applicable to buildings used 
for the various cotton processes we find a normal 
rate laid down, and then if the buildings are not 
" fireproof " additional rates are chargeable for de- 
fective construction, lighting by incandescent gas, 
electro-motors and so on. Buildings rated as " fire- 
proof" and their contents are under this tariff much 
more favorably treated than buildings and contents 
not so rated, and in addition a discount is allowed if 
the buildings rise above the mere description of " fire- 
proof" and conform with the full conditions of a 
standard fire-resisting building. Cotton spinners by 
adopting standard fire-resisting buildings are there- 
fore at the top of the scale and pay the lowest rates, 



222 YALE READINGS IN INSURANCE 

then come those whose buildings are reckoned as 
" fireproof," and then in a long descending scale 
those whose buildings are not fireproof and who have 
besides methods of lighting, working, etc., which call 
for additional rating. I am not able from the con- 
fidential nature of tariffs — several of which by 
courtesy of the Fire Offices' Committee have been 
placed at my disposal — to give more than a cursory 
description of the system, but I may perhaps say 
roughly that a cotton mill which was on the lowest 
plane as regards construction and appliances would be 
charged for fire insurance several times as much as one 
which could rank as a standard fire-resisting building 
with the best appliances. This great difference will 
show how powerful is the inducement for property 
owners to adopt only the best forms of construction 
and appliances. 

I have dealt with additional premiums and we may 
now look at reductions on normal rates for fire-ex- 
tinguishing appliances. An approved installation of 
automatic sprinklers may reduce the rates of pre- 
mium which would otherwise be charged by more 
than half, and large allowances are also made for the 
presence of steam fire engines and a trained brigade 
of firemen. Some allowance is also made for other 
means of fire extinction either by water or chemicals. 

Supposing that a building were classed as standard 
fire-resisting the owner would first get a liberal dis- 
count off the rates charged for " fireproof" buildings 
and appliances, and then if he had a sprinkler installa- 
tion he would get a further discount on the net pre- 
mium, that is, the gross premium less the allowance 
for special construction. 

The system of grading premium rates according to 
risks incurred, which I have briefly sketched, depends 
for accuracy upon elaborate investigations into the 
causes of fires. This inquiry into the causes of fires 



TABULAR RATING IN GREAT BRITAIN 223 

is not less important than classification, since the penal 
rates under a tariff aim at eradicating fires, and they 
cannot be effective unless they are directed at true 
and not imaginary causes. Mr. T. A. Bentley, in a 
paper read before the Manchester Insurance Institute 
in 1899, gave the results of an investigation into the 
fires in cotton mills which had been observed during 
the previous twenty years. It was found that more 
than one-half of the total number were due to friction 
set up during the processes of spinning, etc. Light- 
ing with gas caused 4.3 per cent, of the fires, and an 
alteration in the manner of placing the lights and the 
introduction of electric lighting has removed much of 
this danger. As observed up to 1899 there had only 
been one fire through defective electric installation. 
The unknown causes of fire were 27.6 per cent, of the 
whole, 20.2 per cent, being in mills without a sprinkler 
installation and 7.4 in mills which were installed with 
sprinklers. Mr. Bentley showed by analyzing the 
returns of fires in cotton mills that had occurred from 
1879 to 1898 that there had been great check on the 
fire waste during the period, and that the average loss 
per fire was nearly twice as much in the early part of 
the period as it was throughout the twenty years, and 
that during the latter part, 1894-1898, the loss per 
fire was considerably less than the twenty year aver- 
age. This reduction in the fire waste was attributed 
to improved methods of spinning, etc., the introduc- 
tion of electric light and the fitting of extinguishing 
appliances, especially the introduction of automatic 
sprinklers. It is therefore clear that the efforts of 
the fire offices to encourage the best form of con- 
struction and appliances, the use of electric light 
instead of gas and the provision of extinguishing 
appliances have had a very marked direct effect upon 
the fire waste suffered by cotton mills. I have taken 
this merely as an example and as some indication 



224 YALE READINGS IN INSURANCE 

that the system of differential rating, which is a 
feature of the British tariff, is directed towards defi- 
nite ends and has, as far as can be judged, been in- 
strumental in achieving these ends and in lessening 
fire hazards. 

I have already referred to what may be called the 
cardinal defect of a British tariff, namely, that it 
makes no adequate provision for rating the contents 
of buildings as distinct from the buildings themselves. 
In some cases, as for instance the cotton tariff, a 
slightly higher rate is charged for contents in some 
sections than is charged for buildings, but the addi- 
tions and reductions are based on the general assump- 
tion that the fire risks of contents and buildings are 
the same. Not only is this not the case but the differ- 
ence of risk is in some cases very great. The great 
majority of fire claims are for partial losses and in 
nearly every case of a partial loss the percentage of 
loss to value is greater in the case of stocks than of 
buildings containing them, the loss ratio on stocks 
being sometimes as much as four times as great. By 
rating stocks and buildings together we arrive at two 
inequalities — as the fire risk on stocks is greater than 
on buildings a uniform rate must bring out too small 
a premium for stocks and too large a one for buildings. 
What is more, a system of differential rating which 
might equitably be applied to buildings would cease 
to be equitable when applied to stocks and vice versa. 
This point is clearly brought out by a consideration 
of the principles governing the American Universal 
Schedule, which makes a prominent feature of the 
distinct rating of stocks and buildings. 



CHAPTER XI 

DISCRIMINATION AND COOPERATION IN FTRE INSURANCE 

RATING ■ 

I. Discrimination 

Discrimination in fire insurance rating has two effects. 
First, substantial injustice is done to competitors, be 
those competitors individuals, corporations, or cities; 
second, maladjustment of fire insurance rates has a very 
serious effect upon the annual fire loss of the country. 
Xot much has been heard of this second effect, but there 
are reasons for believing that it is of more importance 
than the injustice which is done to competitors through 
discriminating rates. 

The losses by fire in the United States, direct and in- 
direct, amount to more than half a billion dollars annually. 
Much attention is being directed to this fire waste, and its 
causes and remedies are being sought. A great deal is 
being said about the ignorance of American builders, and 
of the extravagance of Americans in general in allowing 
such a tremendous waste to go on, not diminishing in 
amount, but actually increasing year after year. These 
accusations are largely unfounded. Xowhere in the world 
has the art of constructing fire-proof buildings made such 
progress as in the United States; therefore if Americans 
build badly, it is for some other reason than ignorance. 
Americans may be extravagant in their personal expendi- 
tures, but better building is a business proposition, and it 

1 By Lester W. Zartman. Reprinted from the August number of 
the Yale Review, August, 1909. 

225 



226 YALE READINGS IN INSURANCE 

would be rather difficult to prove that American business 
men as a rule are not quick to take advantage of ways of 
saving money in business. As a matter of fact, a con- 
siderable amount of the loss by fire is suffered in the United 
States because it would be unprofitable to try to prevent 
the loss. The relative costs of combustible construction 
and fire-resisting construction have varied so widely that 
it has been cheaper to build as we have and let buildings, 
and even cities, burn up occasionally than to attempt to 
prevent the loss by constructing better buildings. 

The principle can be laid down that, in general, if fire 
insurance rates are properly adjusted, a community will 
have just that amount of good construction which is 
profitable for it to have. In other words, the problem 
of reducing waste by fire is the problem of the cost of fire- 
proof materials and insurance rates. Prospective builders 
learn how much different types of buildings will cost; 
they then find out what the rate of fire premium is on each 
type and build accordingly. No one can doubt that the 
rates of fire insurance have a tremendous effect upon the 
character of construction. If an improvement in con- 
struction from the fire standpoint is to be made, it will 
come as a result of a reduction in the premium rate for 
insurance. In order to secure the improvement there 
must be enough saving in the insurance to pay interest 
upon the additional capital needed for the better construc- 
tion and enough more to provide a sinking fund to replace 
the extra capital after a certain number of years. There- 
fore one of the most important things to consider in dis- 
cussing the problem of the fire loss is the question of fire 
insurance rating. If rates measure correctly the various 
hazards, then the whole attention may be directed to 
securing cheap fire-proof construction. 

Do the rates of fire insurance measure correctly the 
various hazards? From time to time the charge is made 
that they do not. Why they do not and what attempts 
have been made on the part of the companies to make 



DISCRIMINATION AND COOPERATION 227 

rates conform to hazards, it is the purpose of the present 
paper to show. 

Those who have given the subject of fire insurance 
rating any thought recognize the extreme complexity of 
the problem. In life insurance the medical director of 
each company, in selecting risks, has in mind a standard 
man — not a physically perfect man, but one who he 
thinks will live at least a certain number of years. Every 
applicant who comes up to the requirement of this stand- 
ard man is accepted; with most companies, all those risks 
which do not come up to the standard are rejected. Com- 
petition among the life insurance companies in the payment 
of dividends brings them all to much the same stand- 
ard. How different it is in the fire insurance business! 
Where is the standard building, the average risk? Frame 
buildings have one hazard of burning, brick buildings 
have another; frame churches have one hazard, frame 
factories have an entirely different hazard. There is one 
loss record on frame warehouses that are isolated from 
other buildings, and another loss record on those frame 
warehouses which are adjacent to other buildings. Each 
class of buildings has its own peculiar hazards, and every 
combination of buildings within each class and with those 
of other classes has a different hazard ; the number of com- 
binations, each producing its own risk of fire is infinite. 
Complicate this situation with the hazards of various 
kinds of occupancy, and the problem of getting at correct 
fire rates is apparently insoluble. As if this were not 
enough to make the problem difficult, there is still the 
change ceaselessly taking place in methods and materials 
of construction and in the processes carried on within 
buildings. Human life has experienced some alteration in 
2000 years, but every succeeding phase, at least in modern 
times, has been marked by a greater longevity. This has 
made the business of life insurance constantly more secure. 
In fire insurance the changes in hazards are taking place 
so rapidly that if the companies had had exact data twenty 



228 YALE READINGS IN INSURANCE 

years ago on which to base rates, they would be nearly 
useless to-day. The growth of cities, the concentration 
of population, the building of sky-scrapers, the use of 
electricity for light and power, the changed methods and 
machinery in factories — all these have created, within 
a short period, a new world for the fire insurance business. 

Lastly, to complicate the rating situation, there are the 
conflagrations. The nearest analogy, taking such catas- 
trophes in account, would be life insurance companies 
attempting to carry on their business under the conditions 
which prevailed in mediaeval times in Europe, when ter- 
rible epidemics swept over the country carrying off at times 
a quarter of the population. To carry on the business of 
life insurance under such conditions would be well-nigh 
impossible; yet in the fire insurance field, the conflagra- 
tions to-day are almost as disturbing a factor as such 
epidemics would be in that of life insurance. Feared by 
all careful managers, subject to no known law of average, 
they introduce a new complexity into what is already a 
maze of complexities. 

Under such conditions what progress has been made 
towards securing scientific rating? Space will permit no 
more than a brief outline of the development which has 
taken place. In the early history of fire insurance the 
rating system was extremely simple. All risks were di- 
vided into two classes, brick buildings and frame buildings, 
and the premium on frame buildings was double that on 
brick buildings. About 1720, risks in England were 
divided into three classes, and for a century and a quarter 
this change, with but few modifications, was all the advance 
made by English companies towards scientific fire-rating. 
It was in the year 1800 that companies in New York City 
began first really to classify risks, all risks being grouped 
under four classes, and a rate fixed for each class. Progress 
in rating advanced slowly. As late as 1856, more than a 
century after the establishment of the first fire insurance 
company in America, a prominent official of one of the 



DISCRIMINATION AND COOPERATION 229 

companies asserted* that nothing more was known about 
the actual cost of insuring different risks than was known 
when the first company was established. 

Up to 1835 there was not much need for the companies 
to know the cost of insuring various classes of risks, for 
up to that time the business of each company had been 
largely local. Competition was not keen, and the com- 
panies simply fixed rates high enough to be sure of a 
profit. But when the New York conflagration of 1835 
and another in 1845 showed the companies that it was 
fatal to concentrate their business in one locality conditions 
were seen to have become vastly different; the companies 
began to spread out in order to get a wide distribution 
of risks. They thus came in contact with each other, 
competition became intense, and rates went down. How 
low they could go and still allow a profit to be made the 
managers of the companies did not know. As a matter 
of fact the rates sank too low, and the companies lost 
heavily. This keen competition for business, with the 
consequent fall in profits, had an important effect upon 
the methods of conducting the business. Managers found 
it necessary to know more about the cost on various kinds 
of hazards, and classification of risks was taken up in 
earnest. To-day all the companies are classifying the 
risks which they insure, though this activity amounts 
to scarcely anything, inasmuch as no advance has been 
made over the start given seventy years ago. 

After classification of risks, the next step towards better 
fire-rating was the adoption of the system of rating certain 
classes of risks by schedules. It is not known exactly how 
schedule rating originated. So far as information is 
available, one of the earliest, if not the first, of the applica- 
tions of the method was made in 1852 by the Philadelphia 
Board of Fire Underwriters; the schedule adopted was 
simple and was intended to apply to Philadelphia alone. 
From that time to this a considerable number of schedules 
have been worked out by the various underwriting asso- 



230 YALE READINGS IN INSURANCE 

ciations; at the present time many different schedules 
are in use, though there is a gradual tendency towards the 
adoption of two, the Universal Mercantile Schedule and 
the Dean Schedule, the latter being at the present time 
more popular than any other schedule that has ever been 
devised. 

Schedule rating is, in essence, the attempt to secure 
scientific rating by an elaborate system of classification. 
Under this schedule system, rates are made by applying 
to classes of risks and to individual risks certain predeter- 
mined charges and credits based upon the various factors 
of construction, occupancy, degree of exposure to and of 
protection against fire. For instance, in getting the rate 
for a specific building there is what is known as the basis 
rate, which is the rate made upon a certain type of build- 
ing; in one schedule it is a simple, one-story, brick building; 
in another it is a well-built, five-story building. The basis 
rate having been determined, it is applied to the risk to be 
rated; then the various defects in construction, dangerous 
factors of arrangement and deficiencies in the nature and 
extent of the apparatus for fire protection are listed with 
fixed or percentage charges for each deviation from the 
standard; credits are then allowed in the schedule for 
features of equipment or construction better than those 
possessed by the standard building. Add the charges to 
the basis rate, subtract the credits, the remainder is the 
rate upon the specific risk. This is schedule rating. 

That the system of rating by schedules is a great im- 
provement over the old method of judgment rating is well 
recognized. Especially is the adoption of. the schedule 
system of importance in securing better construction. 
Under the system where the special agent is told that 
the average premium rate on warehouses for the last ten 
years has been one dollar and thirty-two cents, with a loss 
ratio of 43 per cent., and is then sent out to make rates on 
such buildings, no one can tell what rate his particular 
building will receive. If a man is contemplating building 



DISCRIMINATION AND COOPERATION 231 

a new warehouse, or making changes in an old one, and 
desires, if it pays, to improve the fire hazard by better 
construction, all that the agent can do is to tell him to go 
ahead and build, and then a rate will be made. With such 
uncertainty, no one is likely to consider the fire rates a 
great deal. Under a system of schedule rating, even one 
inexperienced in fire insurance matters can take most 
of the schedules and figure out precisely what reduction 
in rate will be given for better construction. Will it pay 
to enclose the elevator wells with brick walls? Look up 
the schedule and find out; for all is determined beforehand. 
The schedule system recognizes to a large extent what 
must be acknowledged, namely, that each building has 
an individuality of its own. Fire insurance must attempt 
to measure the hazard of each individual risk, and fit it 
with a specific rate; and this it does attempt to do through 
the schedule system of rating. 

As has been ' said, the schedule system of rating is a 
great advance over the old method of judgment rating; 
but much remains to be accomplished. If the charges and 
the credits in the schedule were determined by the known 
experience of the companies — if shingle roofs, for ex- 
ample, were penalized 10 per cent, because the hazard of 
burning were known to be increased 10 per cent, by their 
presence, and these charges and credits were continually 
revised in the light of new experience — the business of 
fire insurance would have reached its highest development. 
Such is not the case. Charges and credits are not based 
on facts; the schedules so far constructed have simply 
substituted for the judgment of one rating expert, the 
combined judgment of a number of experts. This can 
well be illustrated by the history of the Universal Mercan- 
tile Schedule: half a dozen different underwriting associa- 
tions appointed representatives to formulate a schedule; 
from the thirty-seven representatives appointed a com- 
mittee of four was chosen, which made up a tentative 
schedule representing the pooled judgment of its members; 



232 YALE READINGS IN INSURANCE 

this schedule was then sent out to all the raters in the vari- 
ous Eastern associations asking for suggestions and criti- 
cisms, in the light of which the committee went over all 
the suggestions, combining them as best it could. This 
process was repeated five times, so that the final schedule 
is the result of the combined judgments of a considerable 
number of men experienced in fire insurance matters; but 
while this method produced a good schedule, the schedule 
lacks the authority which one based on statistical data 
would possess. 

This explanation of the ways in which rates are deter- 
mined has been given in order that the following discus- 
sion of rate discriminations may be better understood. 
The fact to be kept in mind regarding all rates, schedule 
or otherwise, is that they have no statistical basis. To 
show that the fire insurance companies do not have a 
scientific foundation for the rates which they charge does 
not, indeed, prove that the rates are inequitable; unfor- 
tunately, however, for the companies, when under charges 
of discrimination, they cannot prove that their rates are 
just, save in the aggregate. Such lack of knowledge is 
bad for the business, for it causes much hostility on the 
part of the public and results in much unwise legislation. 

Most fire insurance experts will readily admit that dis- 
criminations abound in fire insurance rating. In fact the 
very terminology of the business shows that all classes of 
risks are not rated according to the risk of loss; almost 
since the beginning of the business there have existed 
what are known as preferred classes of risks and others 
known as special hazards. This could not be if all risks 
were rated according to the risk of loss, for under such 
conditions there would be just as much profit in insuring 
mills, warehouses, and stores, as in writing policies on dwell- 
ings and churches. The fact that this terminology of 
preferred and special classes is not merely the result of a 
traditional distinction of earlier times, is betrayed by 
the effort on the part of the companies to secure the pre- 



DISCRIMINATION AND COOPERATION 233 

ferred classes of risks to-day. In many agencies, 10 per 
cent, more commission is given for preferred business 
than is paid for premiums on special hazards. 

Two interesting questions immediately arise; why is it 
that the discriminations in rates are made, and how is it 
that in such a business as freely competitive as is fire 
insurance, the distinction between preferred and special 
risks can be maintained year after year? It will help us 
in answering the former query to distinguish various 
kinds of rate discriminations. First, there is the dis- 
crimination between large classes of risks such, for instance, 
as dwellings on one hand and factories on the other; 
second, there are discriminations between localities; 
and, again, there are unjust rates as between specific risks. 

Taking up in order these varieties of rate discrimination, 
we first ask why there are preferred classes of risks. These 
classes exist because of the desire on the part of the com- 
panies to assess rates in such a way as to arouse the least 
opposition. There are many analogies between fire pre- 
miums and taxes ; as with governments, — which have 
always found it necessary to levy taxes not so much with 
regard to the question of their being ideally just, as to the 
question of whether they can be imposed without raising 
a storm of opposition, — so is it with the fire insurance 
companies. They have found that they can levy high 
rates on dwellings, on contents of dwellings, on churches, 
schoolhouses, public buildings and kindred risks without 
causing much opposition. The reason is not far to seek. 
The rates on dwellings as a class are low, absolutely speak- 
ing; few people have large values, so that the premium 
on each risk is moderate and usually causes little objec- 
tion to be made. Suppose there is some opposition to the 
dwelling rates; it may result in a man complaining to his 
neighbor that the rates on dwellings are too high, and the 
neighbor may agree with him; but this is about as far as 
the opposition ever gets. In the same way high rates on 
churches, schools, and similar property cause little opposi- 



234 YALE READINGS IN INSURANCE 

tion, but how different is the situation if the companies 
make an increase in rates on mercantile or factory risks. 
Practically every city has its trade organization, a chamber 
of commerce, or a board of trade, composed of the leading 
business men of the city. Even a small increase in rates 
on risks owned by these men makes a great deal of differ- 
ence to them, for here values are large. An increase in 
rates on risks owned by these men means opposition — 
and opposition which counts, for the organization already 
exists by which it can be concentrated. The influence 
which these boards of trade and similar organizations 
can have upon legislation is so powerful that any rating 
organization thinks twice before it raises rates upon mer- 
cantile and manufacturing risks. 

The next question which follows from this description 
of the condition in fire insurance is why in a business so 
fiercely competitive as fire insurance there can continue 
to exist permanent classes of preferred risks. If the old 
companies are in an agreement to maintain rates, why are 
not new companies organized to compete for the preferred 
business, thus bringing rates down to cost? Suppose a 
company were organized to make a drive for the preferred 
business. It could get it in two ways: it could either 
establish new agencies, or it could try to enter into already 
established agencies. Suppose it chose to establish new 
agencies, and by reducing rates on dwellings attempted to 
secure business; about the first man who was approached 
by the agent of the reduced-rate-on-dwellings company 
would say, ''Reduced fire insurance premiums are just 
what I want. At what rate can you write my factory?" 
The agent would have to reply that he could not write the 
factory at all. The dwelling-house owner would answer 
that, if the agent could not write the factory he would 
not change any of his insurance, as the old agent who had 
always handled his business had had a pretty hard time 
placing the factory, and it would not be fair to take the 
dwelling away from him. Thus the agent for the pre- 



DISCRIMINATION AND * COOPERATION 235 

ferred class company would have an extremely difficult 
task in getting much business. 

Suppose then our company, instead of establishing new 
agencies, attempted to get into established agencies which 
already control many risks. The local agents have no use 
for a company which writes preferred risks at reduced 
rates. A local agent usually represents a number of com- 
panies, and any of these is perfectly willing to handle all 
of the preferred business which the agent controls. The 
problem with the local agent is, as we shall see, to dispose 
of his specials. He can do so only by shrewdly mixing 
them up with his preferred lines. If he gave the preferred 
business to an outside company, he could not place his 
less acceptable risks. Thus it is that the local agent 
refuses ordinarily to represent the reduced rate company, 
and the company organized to specialize in preferred 
classes must get business in some other way than by redu- 
cing rates. 

There are companies which make a specialty of pre- 
ferred business, but their entry into the field and their 
success in it has not brought about a better adjustment 
of fire insurance rates. Rather have they made it worse, 
for, unable to secure business in either of the ways sug- 
gested above, they have purchased it by the payment of 
excessive commissions. While they have found it im- 
possible to get agents to give them the preferred business 
by offering to write it at lower rates of premium, they have 
found it possible to get some agents to give them a share 
of it at the old rates by offering more commission than the 
other companies are accustomed to give. By doing this 
they have not benefited the public by making rates more 
equitable, for rates have not been reduced; rather have 
they worked harm by increasing the expenses of the busi- 
ness. Thus are explained the existence and continuance of 
preferred and special hazards in fire insurance. 

The second kind of maladjustment of fire insurance rates 
is that between different localities. Reference is made to 



236 YALE READINGS IN INSURANCE 

the relative rates between those risks which are subject 
to the conflagration hazard and those which are not so 
subject. It has been asserted that if the companies would 
publish their experience in the ten largest cities of the 
country, it would be shown that in every one the companies 
have lost money. That rates should be universally too 
low in the larger cities, thus encouraging poor construction 
where good construction is most needed, is due to a number 
of causes. In the first place, there are the conflagrations. 
A conflagration is of such sporadic occurrence that, under 
the conditions of competition which have prevailed, it 
cannot be taken into consideration in making rates; that 
this is true is lamentable, since the best remedy for con- 
flagrations would be the penalty of high insurance rates 
upon those cities where a conflagration is possible. 

The conflagration, however, is not the only cause of 
unprofitable underwriting in large cities. Even the cities 
which have not suffered from conflagrations show a 
balance on the wrong side from the fire insurance stand- 
point. Another cause must be sought; and it is to be 
found in the conditions under which the sale of fire insur- 
ance takes place in large cities. The city has evolved the 
fire insurance broker, who is shrewder in many cases than 
the underwriters with whom he deals. He takes advantage 
of the ignorance of the companies in not knowing the cost 
value of the commodity in which they deal, and, pitting 
one company against another, is able to drive a hard 
bargain. Yet, notwithstanding the unremunerative rates, 
the large cities are to the average manager tempting ground 
for work; policies can be written for large amounts and a con- 
siderable premium income easily secured. The result is that 
ambitious managers can scarcely refrain from establishing 
agencies in the large cities; this makes competition for 
business severe, and where cooperation among the com- 
panies is needed most to hold off the broker, cooperation is 
almost impossible because of the number of companies and 
the number of agencies. Without cooperation, rates are 



DISCRIMINATION AND COOPERATION 237 

cut and exorbitant commissions given for poor business. 
Thus it is that in the places where the heaviest penalty 
ought to be placed on poor construction, the tendency is 
to make it light, and the day of fire-proof cities is put 
further away. 

We come now to a discussion of the last kind of mal- 
adjustment of rates, namely, those discriminations in 
rates which are made between specific risks rather than 
between classes of risks as a whole. There are several 
causes for these discriminations. In the first place, com- 
panies frequently accept risks at rates, which they know 
to be grossly inadequate for the risk assumed, simply 
because they do not wish to offend local agents. To 
understand how this is so it is necessary to explain briefly 
how the agency system is organized. A local fire insur- 
ance agent frequently represents from four to twelve, 
sometimes even twenty different companies; an agent 
who controls large risks needs to represent that many 
companies, else he could not place all his insurance with- 
out dividing up commissions with other agents. The 
amount, or the "line," as it is technically called, which 
one company is willing to write on one risk is limited. 
When a risk is so large that all the companies in an agency 
get as large a line as each one wants on the risk, there is 
no quarrel between them; the conflict of interests arises 
with the smaller risks, and every company, through its 
special agents, is continually urging the local agent to give 
it a larger proportion of these smaller risks. On the other 
hand, the local agent has an assortment of risks under his 
control which no company wants very much at any rate, 
and a good many risks which none of the companies want 
at the rate which is offered. And so he takes advantage 
of the situation and offers to one of his companies a number 
of choice risks, preferred business, along with a number of 
risks which are not so choice. The company can take all, 
or refuse all; for the local agent will not allow it to pick 
the good and leave the bad. Thus by shrewdly playing 



238 YALE READINGS IN INSURANCE 

one company off against another, and by carefully mixing 
up his risks, the local agent is able to force the companies 
to take risks which they ought not to take at the rates 
which are offered. Of course, if it were not for the existence 
of the preferred business, the agent could not get the poor 
risks in, but the preferred business exists, and the manager 
of the fire insurance company, in order to get his share of 
it, will accept many risks at inadequate rates. 

Another reason why rates on specific risks are not fixed 
in proportion to the hazard of loss is because the principle 
of charging what the commodity will bear holds true in 
fire insurance just as it does in almost every business 
where there are large fixed expenses. The way in which 
this element of fixed expenses, with the consequent cutting 
of rates, enters into the fire insurance business can be 
shown best by an example. Let us assume that a com- 
pany has established itself in a large number of agencies 
all over the country; to carry on the business profitably it 
must have a well-organized force of special agents, and a 
highly trained home office staff. Under these conditions 
let us assume further that a risk, say a factory, is offered 
to the company; the company wants the business, but 
competition is keen, and a competitive rate must be named. 
To find out this competitive rate, it is only necessary to 
analyze the expenditure of the company. The total 
premium income, in general, is paid out as follows: 

Losses 55 per cent. 

Commissions 15 

Salaries of special agents ' . . 5 

Maintenance of home office 15 

Taxes 3 

Profit 7 

If the burning ratio on the class to which the factory in 
question belongs is $.825 per hundred, in order to get 
the current rate of profit, to charge the factory its pro- 
portion of the fixed expenses and to pay the agent the 



DISCRIMINATION AND COOPERATION 239 

regular commission, the company would have to name a 
rate of $1.50 per hundred on the factory. It will not 
charge that rate if a lower rate is necessary to secure the 
business from a rival, and it need not in order to make 
acceptance of the business profitable; as the expenses for 
special agents and home office force will continue whether 
that risk is accepted or not, and both of these can be ignored 
in making the rate. The tax will have to be paid, and some 
commission to the local agent, though at times the agent 
is willing to take a smaller commission in order to induce 
his company to accept the risk. Therefore, the company 
can fix a rate of $1.00 on the risk and still make a profit as 
follows: 

Expected loss $.825 

Taxes 03 

Commission ; 10 

which makes a total expense of $.955, leaving a profit 
of nearly 5 per cent, to the company upon the transaction, 
even with the heavy reduction in rate. This assumed 
situation reflects precisely the real condition in the fire 
insurance world when that business is subject to free 
competition; it explains the rate wars which formerly 
occurred frequently, and which some large insurers and 
legislators would evidently like to have occur again. 

Along with these improper adjustments of rates another 
allied charge is made against the fire insurance companies, 
namely, that the companies will not reduce rates readily 
when hazards are reduced by the adoption of better forms 
of construction or of fire-preventing devices. Some very 
good fire insurance men have said that they are not in- 
terested in reducing the fire loss; that it is the only func- 
tion of fire insurance companies to take losses as they 
find them and to assess them on the community. They are 
right. That is precisely their function; only they must 
be sure that they take hazards as they find them and not 
as they do not find them. 



240 YALE READINGS IN INSURANCE 

In summing up the situation in regard to fire insurance 
rates, it has been found that in three different respects 
rates are not adjusted to the hazard of loss. There are 
preferred classes of risks; cities are not penalized for their 
liability to suffer conflagration losses; and there are 
many individual risks taken at improper rates. Such 
maladjustment of fire insurance rates has two effects: 
first, it is a serious factor in the business world where com- 
petition is severe; second, it has a most important effect 
upon the amount of the annual waste by fire. That waste 
alone is becoming so great that strenuous effort should be 
made to lessen it; and so far as it is increased by im- 
proper fire insurance rating, every attempt to secure a 
better rating system should be eagerly welcomed. 



DISCRIMINATION AND COOPERATION 241 

II. Cooperation 

In the preceding section, it has been pointed out that 
rate discriminations in fire insurance prevail. Such a 
showing is no reflection upon the ability or the motives 
of the managers of our fire insurance companies; it is 
not a result which any of them desires. In fact, the 
officers of the companies are more directly interested in 
stopping these rate discriminations than is the public; 
they would like very well indeed to have some plan de- 
vised whereby the fire loss could be equitably assessed 
on the different classes of risks. Frequently the impos- 
sibility of assessing the fixed charges upon some risks has 
become so general that the fixed charges are not collected 
at all, and the companies have ended the year with losses 
instead of gains to their credit. To prevent this situa- 
tion from recurring and to secure better conditions in the 
fire insurance world, the companies have found it neces- 
sary to work together, to form what are commonly known 
as fire insurance compacts or combinations. These com- 
pacts are of such great importance in the fire insurance 
business and are the subject of so much public discussion 
that it will be well for us to analyze carefully the objects 
for which they are formed, and to find out, if we can, the 
legitimacy of each object. The companies have cooperated 
for the following purposes: 

1. To regulate rates. 

2. To regulate commissions. 

3. To secure effective and economical supervision of 
risks. 

4. To study hazards. 

5. To repress incendiarism. 

Is it to the advantage of the public that the companies 
should be allowed to cooperate to secure these objects, 
or is it to the injury of the public? Let us consider each 
of the objects in order. Is a system of compact rating 
better for the public than rates made by competition? 



242 YALE READINGS IN INSURANCE 

We have just learned that there are three ways in which 
discriminations in rates are made. These evils are almost 
entirely the result of competitive conditions. If the com- 
panies could cooperate closely enough they could do away 
with preferred classes, and increase rates on the special 
hazards. They do not dare to increase rates on the latter 
class because they are afraid that the men who own them 
will go to their legislatures and get laws enacted forbid- 
ding all cooperation among the companies. The large 
cities get relatively low rates because of the competitive 
conditions; and the third variety of discrimination which 
has been described is due entirely to competition. If 
these evils in rating are the result of free competition 
between the companies then the way to abolish them is 
to allow the companies to cooperate in making compact 
rates. 

The second object which the companies have sought to 
obtain through cooperation is the regulation of commis- 
sions paid to agents for securing business. There is almost 
as much necessity for tariff commissions as there is for 
tariff rates. There are two ways of increasing the business 
of a company; one way is to cut rates, and the other is 
to increase commissions. In many cases the latter method 
is more successful than the former; to understand how 
this is true it is only necessary to recall the peculiar organ- 
ization of the agencies. Instead of a company having in 
a city an agent who represents it exclusively, it has one 
who may represent a dozen of its most powerful competi- 
tors. This is a situation — a number of rivals having a 
common representative — found in few other businesses, 
and the result is competition for business within the agency. 
If this is unchecked, it takes the form of giving larger com- 
missions for business. A local agent controls a certain 
number of risks; a special agent may stir him up to solicit 
more risks and thus increase his company's business, or the 
special may offer more commission to increase his com- 
pany's business at the expense of the competing com- 



DISCRIMINATION AND COOPERATION 243 

panies in the same agency. The competing companies 
retaliate by likewise increasing commissions, and the war 
goes on until all, or even more than all, the profits go to 
the agents in the shape of commissions. A union among 
the companies to regulate commissions has to be formed, 
or all will become bankrupt. 

From the standpoint of the public this commission de- 
moralization is even more serious than is rate demoraliza- 
tion; if rates are cut the public gets the benefit, while in 
a commission fight expenses may be so increased as to 
make a rise in rates necessary. With no commission 
tariff, an improvement in the hazard means only an in- 
creased commission paid by some company to secure the 
business from another company; while losses are reduced, 
expenses are increased and the net result is the same to 
the public. Even from this brief discussion of the com- 
mission problem it is safe to conclude that cooperation in 
the matter of commissions is almost as essential as coopera- 
tion in rating. 

The third object which the companies seek to obtain 
through cooperation is effective and economical inspec- 
tion of risks. If rates are ever to be adjusted to hazards, 
it will come through better inspection of risks. One of 
the most serious objections which has been raised to 
present fire-rating is that good and bad risks are lumped 
together in one class and given too nearly the same rate; 
plainly the only way in which the companies can safely 
discriminate between good and bad risks is by making a 
careful inspection of all the risks insured. There is nothing 
to prevent all the companies from making such an inspec- 
tion, each for itself, except the expense of doing it. But 
this is an insuperable difficulty; for if each company were 
forced to inspect carefully each risk that it insured, the 
expense of such inspection would probably be much greater 
than the saving in losses which would result from having 
rates closely adjusted to hazards. And there is a still 
more serious objection to inspection of risks by individual 



244 YALE READINGS IN INSURANCE 

companies; no matter how thoroughly a representative 
of a single company may go about the inspection of risks 
he is not going to accomplish much in the improvement 
of hazards. Consider the situation as it existed before 
the companies began to cooperate in inspection. A com- 
pany's special agent would visit a risk; and though he 
might see conditions which seriously increased the hazards 
of fire, yet the knowledge that other companies were 
anxious to write the risk as it was, and that even a reason- 
able request on his part would cause ill-will toward his 
company, would deter him from requiring the removal of 
defects which he knew to be serious, but which other com- 
panies had passed unchallenged. It is the same old story 
of competition. 

How different is the situation when the leading com- 
panies cooperated and established inspection bureaus! No 
matter how many companies are now on a risk, only the 
authorized representatives of the inspection bureau visit 
the risk; and since a few men are performing the function 
hitherto performed by many, experts can be employed, 
and more efficient inspection is secured. Not only is the 
inspection more efficient, but the recommendations made, 
carry with them weight far greater than those made by 
the representative of the individual company. Under the 
old system the owner could view with serenity the can- 
celation of the policy of one company, since he knew that 
he could get insurance from another; with the companies 
associated together, the improvements recommended by 
the inspection bureau must be made, or the policies, not 
of one company, but of all the union companies, will be 
canceled. The effect of this cooperation is that improve- 
ments have been made; and many classes which were 
once unprofitable at any rate which competition would 
allow the companies to secure, have become profitable 
even at lower rates — a happy situation for the insurance 
companies as well as for the public. 

Very closely connected with the plan of providing for 



DISCRIMINATION AND COOPERATION 245 

thorough and economical inspection is the fourth object 
of associated effort, the study of fire hazards and fire pre- 
vention. While it is perhaps true that the stock fire 
insurance companies are not primarily interested in redu- 
cing the fire loss, competition of the mill mutual s and of 
the preferred class companies for certain classes of risks 
has forced the companies writing all classes to give atten- 
tion to the study of hazards. Companies have found that 
with many classes of risks rates must be closely adjusted 
to hazards. If they are not, the good mills and factories 
will go to the factory mutuals, and the better risks in 
other classes to the non-union, preferred-risk companies 
which are always looking for profitable business. There- 
fore in order to forestall competition, actual or latent, the 
associated companies have found it necessary to establish 
a laboratory for the study of the hazard of new processes, 
the value of new methods of fire prevention, and like 
topics. Here again, it might be possible for one company 
to make these experiments; but again we may be sure 
that one company acting alone would not attempt it. It 
is to the interest of all the companies doing a general 
agency business to have such studies made of hazards; 
therefore the companies not only ought to be allowed to 
cooperate for this purpose, but encouraged to do so. 

The last object which the companies have attempted 
to secure through cooperation is a reduction of losses 
caused by incendiaries. Each company has to guard it- 
self against the first act of an incendiary; but through 
cooperation the companies can protect one another from 
further loss at the hand of the same incendiary. Under 
the system as carried out at present, whenever a company 
finds out or suspects that a loss has been due to a desire 
on the part of some one to sell out to the insurance com- 
pany at a fancy price, it notifies a central bureau which 
sends out to all companies a list of all persons suspected 
of incendiary tendencies. 

Besides the effort to keep track of incendiaries, as above 



246 YALE READINGS IN INSURANCE 

described, the companies' associations seek in other ways 
to discourage losses due to moral hazard. Rewards are 
offered for the punishment of incendiaries, suspected crim- 
inals are prosecuted, and in other ways a great deal has been 
accomplished. Since such work is for the good of all the 
companies, the burden of expense should be borne by all. 

What, then, is our conclusion regarding efforts at co- 
operation among the companies? It is that such coopera- 
tion is highly desirable from every point of view. 

This conclusion is the exact opposite of that reached 
by the legislatures of nearly half of our states; twenty- 
three legislatures have thought that it was detrimental to 
the interests of the public that the fire insurance companies 
should be allowed to cooperate, particularly in the matter 
of rates and commissions. It was in 1883 that Michigan 
passed the first of the so-called " anti-compact" laws; 
this measure provided that no fire insurance company 
should enter into an agreement with another company 
the object of which was to prevent free and open competi- 
tion between it and other companies. Michigan's action 
was followed by Ohio and New Hampshire in 1885, by 
Kansas, Missouri, Nebraska, and Texas in 1889, by Georgia 
in 1891, by Iowa, Alabama, and Wisconsin in 1897 and by 
others until at present (July, 1909), as has been stated, 
such laws are in force in twenty-three of the states. 

There have been a number of motives actuating the 
state legislatures in passing such laws. The ostensible 
reason always given has been the fear of a fire insurance 
trust which would be able to dictate the price of insurance, 
and which, having this power over rates, would raise them. 
Admitting for the moment that such a trust is possible, 
its existence would doubtless be better than a condition 
of free competition. It is not high rates in fire insurance 
which cause the greatest evils; the rates which do the most 
injury are those which do not measure the hazard of loss. 
Not even the demonstration that a fire insurance trust 
is possible will justify anti-compact laws. 



DISCRIMINATION AND COOPERATION 247 

But there cannot be a fire insurance trust which, be- 
cause of its ability to dictate prices, is able to secure 
unusual profits for its members. In order to have a com- 
bination with power to dictate prices arbitrarily, such a 
combination must have a monopoly of some kind. The 
fire insurance combination, or union, has no monopoly, 
unless it be the monopoly of experience; and this is the 
very thing which a compact among the companies makes 
the common property of any one who wishes to enter into 
the business. In order to make a rating compact prac- 
ticable, there must be printed a tariff of rates upon all 
risks in every community. It is true that the union com- 
panies make a pretense at keeping these printed tariffs 
from outsiders, but such attempts are wholly farcical; the 
tariffs are printed, they are placed in the hands of a dozen 
— sometimes hundreds — of agents, and any one can learn 
without a great deal of trouble the rate upon any risk. 
This is the rate which the well-established companies deem 
sufficient for the risk; and thus it is that a new company 
without experience is able through the printed schedule 
to take advantage of the experience of the older com- 
panies. It has been truly said that instead of a rate union 
preventing competition, rather is it the nursing bottle for 
young companies. That it is impossible to establish a 
fire insurance association or union endowed with danger- 
ous power over rates ought readily to be recognized from 
the ease with which new companies are organized. No 
business is easier to undertake than that of, fire insurance; 
no expensive plant has to be acquired as in the case of 
manufacturing, no expensive right of way secured as for 
railroading; in most of the states, any one can organize a 
fire insurance company and begin business as soon as a 
cash capital of $100,000 has been raised. This fact that 
companies are so easily organized represents a very effec- 
tive control over prices. The best-working fire insurance 
union in the country has never been able to raise the price 
of fire indemnity high enough to recoup conflagration 



248 YALE READINGS IN INSURANCE 

losses. If the compacts cannot enable the companies to 
provide for the conflagration hazard, it seems as if there 
were little ground for fearing that a fire insurance trust 
will exercise undue control over rates. 

There is reason for believing that agitation against the 
compacts because of their monopoly feature is simply a 
cover of other motives for attacking the compacts. Under 
conditions of free competition in fire insurance, rates, as 
we have seen, are demoralized; but this is a desirable state 
of affairs for some insurers. In the first place, with no 
compacts, rates will be a matter of bargaining, and the 
shrewdest bargainers in the community will get their in- 
surance the cheapest. Competition among the companies 
is the keenest for large risks such as are found in the manu- 
facturing and mercantile businesses; and the men in charge 
of these large business enterprises are in charge because 
they possess greater ability than do their smaller competi- 
tors. The situation, then, in fire insurance with no com- 
pacts, is fierce competition for the large risks on the part 
of the insurance companies, and shrewd bargaining ability 
on the part of those controlling the risks; and the result 
is low rates for the large risks. We discover here the rea- 
son why large manufacturers and large owners of risks are 
always found fomenting anti-compact legislation directed 
at fire insurance companies; and, to a considerable extent, 
the reason why that legislation has spread widely over the 
country. 

Perhaps it is unnecessary, in view of what has been 
said, to describe several periods in our history during 
which the fire insurance companies were unable to co- 
operate. We have passed through several such periods. 
The years 1855 to 1865 were years in which the companies 
could not get together on rates. There existed that condi- 
tion of free competition so alluring to the enemies of fire 
insurance combinations; and what was the result? At the 
end of 1865, forty-six out of the one hundred and forty- 
five companies reporting to the New York Insurance 



DISCRIMINATION AND COOPERATION 249 

Department had impaired their capitals to the extent 
of a million and a half of dollars; in other words the stock- 
holders were paying for the privilege of furnishing insur- 
ance. Of course such a situation could not continue, for 
losses cannot permanently be paid out of capital. The 
crisis was met by a combination among the companies. 
Supposing such a combination to have been impossible 
through uniform action of all the states and the life and 
death struggle must have gone on between the companies 
until only a few were left. Then the difficulty in securing 
enough insurance would have sent rates up; then, as rates 
went up, profits would have increased, new capital would 
have been attracted to the business, severe competition 
would have ensued, and the old cycle of events would 
have been repeated once more. Such a disturbance in 
business conditions would have been a severe burden 
upon industry. 

Finally it is interesting to recall the nature of the policy 
pursued by other countries in regard to fire insurance 
associations. In England there is one tariff association 
of practically all the companies, which has enjoyed a con- 
tinuous existence since 1858; this association determines 
the rates for all important classes of risks, and so well 
have rates been adjusted to hazards that owners have 
never found it necessary to organize mutual companies. 
The same situation is found in the other European coun- 
tries. In none are the associations illegal, and in all they 
are recognized as necessary for the best conduct of the 
business. 



CHAPTER XII 

STANDARD FIRE INSURANCE POLICY ' 

1. The fire insurance company in consider- 
ation of the stipulations herein named and of 

dollars premium, does insure for the term of 

from the day of 190 . . , at 

noon, to the day of 190 . . , at noon, 

against all direct loss or damage by fire, except as herein- 
after provided, to an amount not exceeding 

dollars, to the following described property while located 
and contained as described herein, and not elsewhere, 
to wit: 

2. This company shall not be liable beyond the actual 
cash value of the property at the time any loss or damage 
occurs, and the loss or damage shall be ascertained or 
estimated according to such actual cash value, with proper 
deduction for depreciation however caused, and shall in 
no event exceed what it would then cost the insured to 
repair or replace the same with material of like kind and 
quality; said ascertainment or estimate shall be made by 
the insured and this company, or, if they differ, then by 
appraisers, as hereinafter provided; and, the amount of 
loss or damage having been thus determined, the sum for 
which this company is liable pursuant to this policy shall 
be payable sixty days after due notice, ascertainment, 
estimate, and satisfactory proof of the loss have been 
received by this company in accordance with the terms 
of this policy. It shall be optional, however, with this 

1 A copy of the printed conditions of the New York standard fire 
insurance policy. 

250 



STANDARD POLICY FORM 251 

company to take all, or any part, of the articles at such 
ascertained or appraised value, and also to repair, rebuild, 
or replace the property lost or damaged with other of like 
kind and quality within a reasonable time on giving 
notice, within thirty days after the receipt of the proof 
herein required, of its intention so to do; but there can be 
no abandonment to this company of the property described. 

3. This entire policy shall be void if the insured has 
concealed or misrepresented, in writing or otherwise, any 
material fact or circumstance concerning this insurance 
or the subject thereof; or if the interest of the insured in 
the property be not truly stated herein; or in case of any 
fraud or false swearing by the insured touching any matter 
relating to this insurance or the subject thereof, whether 
before or after a loss. 

4. This entire policy, unless otherwise provided by 
agreement indorsed hereon or added hereto, shall be void 
if the insured now has or shall hereafter make or procure 
any other contract of insurance, whether valid or not, on 
property covered in whole or in part by this policy; or if 
the subject of insurance be a manufacturing establishment 
and it be operated in whole or in part at night later than 
ten o'clock, or if it cease to be operated for more than ten 
consecutive days; or if the hazard be increased by any 
means within the control or knowledge of the insured; or 
if mechanics be employed in building, altering, or repair- 
ing the within-described premises for more than fifteen 
days at any one time; or if the interest of the insured be 
other than unconditional and sole ownership; or if the sub- 
ject of insurance be a building on ground not owned by 
the insured in fee-simple ; or if the subject of insurance be 
personal property and be or become incumbered by a 
chattel mortgage; or if, with the knowledge of the insured, 
foreclosure proceedings be commenced or notice given of 
sale of any property covered by this policy by virtue of 
any mortgage or trust deed; or if any change, other than 
by the death of an insured, take place in the interest, title, 



252 YALE READINGS IN INSURANCE 

or possession of the subject of insurance (except change 
of occupants without increase of hazard), whether by legal 
process or judgment or by voluntary act of the insured, 
or otherwise; or if this policy be assigned before a loss; or 
if illuminating gas or vapor be generated in the described 
building (or adjacent thereto) for use therein; or if (any 
usage or custom of trade or manufacture to the contrary 
notwithstanding) there be kept, used, or allowed on the 
above-described premises, benzine, benzole, dynamite, 
ether, fireworks, gasoline, greek fire, gunpowder exceeding 
twenty-five pounds in quantity, naphtha, nitro-glycerine 
or other explosives, phosporus, or petroleum or any of 
its products of greater inflammability than kerosene oil 
of the United States standard (which last may be used for 
lights and kept for sale according to law, but in quantities 
not exceeding five barrels, provided it be drawn and lamps 
filled by daylight or at a distance not less than ten feet from 
artificial light); or if a building herein described, whether 
intended for occupancy by owner or tenant, be or become 
vacant or unoccupied and so remain for ten days. 

5. This company shall not be liable for loss caused 
directly or indirectly by invasion, insurrection, riot, civil 
war or commotion, or military or usurped power, or by 
order of any civil authority; or by theft; or by neglect of 
the insured to use all reasonable means to save and pre- 
serve the property at and after a fire or when the property 
is endangered by fire in neighboring premises; or (unless 
fire ensues, and, in that event, for the damage by fire only) 
by explosion of any kind, or lightning; but liability for 
direct damage by lightning may be assumed by specific 
agreement hereon. 

6. If a building or any part thereof fall, except as the 
result of fire, all insurance by this policy on such building 
or its contents shall immediately cease. 

7. This company shall not be liable for loss to accounts, 
bills, currency, deeds, evidences of debt, money, notes, or 
securities; nor, unless liability is specifically assumed 



STANDARD POLICY FORM 253 

hereon, for loss to awnings, bullion, casts, curiosities, 
drawings, dies, implements, jewels, manuscripts, medale, 
models, patterns, pictures, scientific apparatus, signs, store 
or office furniture or fixtures, sculpture, tools, or property 
held on storage or for repairs; nor, beyond the actual 
value destroyed by fire, for loss occasioned by ordinance 
or law regulating construction or repair of buildings, or 
by interruption of business, manufacturing processes, or 
otherwise; nor for any greater proportion of the value 
of plate glass, frescoes, and decorations than that which this 
policy shall bear to the whole insurance on the building 
described. 

8. If an application, survey, plan, or description of 
property be referred to in this policy it shall be a part of 
this contract and a warranty by the insured. 

9. In any matter relating to this insurance no person, 
unless duly authorized in writing, shall be deemed the agent 
of this company. 

10. This policy may by a renewal be continued under 
the original stipulations, in consideration of premium for 
the renewed term, provided that any increase of hazard 
must be made known to this company at the time of 
renewal or this policy shall be void. 

11. This policy shall be canceled at any time at the re- 
quest of the insured; or by the company by giving five 
days' notice of such cancellation. If this policy shall be 
canceled as hereinbefore provided, or become void or cease, 
the premium having been actually paid, the unearned 
portion shall be returned on surrender of this policy or 
last renewal, this company retaining the customary short 
rate; except that when this policy is canceled by this 
company by giving notice, it shall retain only the pro rata 
premium. 

12. If, with the consent of this company, an interest 
under this policy shall exist in favor of a mortgagee or 
of any person or corporation having an interest in the sub- 
ject of insurance, other than the interest of the insured 



254 YALE READINGS IN INSURANCE 

as described herein, the conditions hereinbefore contained 
shall apply in the manner expressed in such provisions 
and conditions of insurance relating to such interest as 
shall be written upon, attached, or appended hereto. 

13. If property covered by this policy is so endangered 
by fire as to require removal to a place of safety, and is 
so removed, that part of this policy in excess of its propor- 
tion of any loss and of the value of property remaining 
in the original location shall, for the ensuing five days only, 
cover the property so removed in the new location; if 
removed to more than one location, such excess of this 
policy shall cover therein for such five days in the propor- 
tion that the value in any one such new location bears 
to the value in all such new locations; but this company 
shall not, in any case of removal, whether to one or more 
locations, be liable beyond the proportion that the amount 
hereby insured shall bear to the total insurance on the 
whole property at the time of fire, whether the same cover 
in new location or not. 

14. If fire occur, the insured shall give immediate 
notice of any loss thereby in writing to this company, 
protect the property from further damage, forthwith 
separate the damaged and undamaged personal property, 
put it in the best possible order, make a complete 
inventory of the same, stating the quantity and cost of 
each article and the amount claimed thereon; and, within 
sixty days after the fire, unless such time is extended in 
writing by this company, shall render a statement to this 
company, signed and sworn to by said insured, stating the 
knowledge and belief of the insured as to the time and 
origin of the fire; the interest of the insured and of all 
others in the property; the cash value of each item thereof 
and the amount of loss thereon; all encumbrances thereon; 
all other insurance, whether valid or not, covering any of 
said property; and a copy of all the descriptions and 
schedules in all policies; any changes in the title, use, 
occupation, location, possession, or exposures of said 



STANDARD POLICY FORM 255 

property since the issuing of this policy; by whom and 
for what purpose any building herein described and the 
several parts thereof were occupied at the time of fire; 
and shall furnish, if required, verified plans and specifica- 
tions of any building, fixtures, or machinery destroyed 
or damaged; and shall also, if required, furnish a cer- 
tificate of the magistrate or notary public (not interested 
in the claim as a creditor or otherwise, nor related to the 
insured) living nearest the place of fire, stating that he has 
examined the circumstances and believes the insured has 
honestly sustained loss to the amount that such magistrate 
or notary public shall certify. 

15. The insured, as often as required, shall exhibit to 
any person designated by this company all that remains 
of any property herein described, and submit to examina- 
tions under oath by any person named by this company, 
and subscribe the same; and, as often as required, shall 
produce for examination all books of account, bills, in- 
voices, and other vouchers, or certified copies thereof 
if originals be lost, at such reasonable place as may be 
designated by this company or its representative, and shall 
permit extracts and copies thereof to be made. 

16. In the event of disagreement as to the amount of 
loss the same shall, as above provided, be ascertained by 
two competent and disinterested appraisers, the insured 
and this company each selecting one, and the two so chosen 
shall first select a competent and disinterested umpire; 
the appraisers together shall then estimate and appraise 
the loss, stating separately sound value and damage, and, 
failing to agree, shall submit their differences to the um- 
pire; and the award in writing of any two shall determine 
the amount of such loss; the parties thereto shall pay the 
appraiser respectively selected by them and shall bear 
equally the expenses of the appraisal and umpire. 

17. This company shall not be held to have waived any 
provision or condition of this policy or any forfeiture 
thereof by any requirement, act, or proceeding on its part 



256 YALE READINGS IN INSURANCE 

relating to the appraisal, or to any examination herein 
provided for; and the loss shall not become payable until 
sixty days after the notice, ascertainment, estimate, and 
satisfactory proof of the loss herein required have been 
received by this company, including an award by ap- 
praisers when appraisal has been required. 

18. This company shall not be liable under this policy 
for a greater proportion of any loss on the described prop- 
erty, or for loss by and expenses of removal from premises 
endangered by fire, than the amount hereby insured shall 
bear to the whole insurance, whether valid or not, or by 
solvent or insolvent insurers, covering such property, and 
the extent of the application of the insurance under this 
policy or of the contribution to be made by this company 
in case of loss, may be provided for by agreement or con- 
dition written hereon or attached or appended hereto. 
Liability for reinsurance shall be as specifically agreed 
hereon. 

19. If this company shall claim that the fire was caused 
by the act or neglect of any person or corporation, private 
or municipal, this company shall, on payment of the loss, 
be subrogated to the extent of such payment to all right 
of recovery by the insured for the loss resulting therefrom, 
and such right shall be assigned to this company by the 
insured on receiving such payment. 

20. No suit or action on this policy, for the recovery of 
any claim, shall be sustainable in any court of law or equity 
until after full compliance by the insured with all the fore- 
going requirements, nor unless commenced within twelve 
months next after the fire. 

21. Wherever in this policy the word " insured" occurs, 
it shall be held to include the legal representative of the 
insured, and wherever the word "loss" occurs, it shall 
be deemed the equivalent of "loss or damage." 

22. If this policy be made by a mutual or other company 
having special regulations lawfully applicable to its organ- 
ization, membership, policies, or contracts of insurance, 



STANDARD POLICY FORM 257 

such regulations shall apply to and form a part of this 
policy as the same may be written or printed upon, at- 
tached, or appended hereto. 

23. This policy is made and accepted subject to the 
foregoing stipulations and conditions, together with such 
other provisions, agreements, or conditions as may be 
indorsed hereon or added hereto, and no officer, agent, 
or other representative of this company shall have power 
to waive any provision or condition of this policy except 
such as by the terms of this policy may be subject of 
agreement indorsed hereon or added hereto, and as to 
such provisions and conditions no officer, agent, or repre- 
sentative shall have such power or be deemed or held to 
have waived such provisions or conditions unless such 
waiver, if any, shall be written upon or attached hereto, 
nor shall any privilege or permission affecting the insurance 
under this policy exist or be claimed by the insured unless 
so written or attached. 



CHAPTER XIII 

THE NATURE OF THE POLICY CONTRACTS * 

The whole theory of fire insurance is logically derived 
from the axiom that insurance is a means of providing 
indemnity for loss. This principle as applied to the opera- 
tions of fire insurance can be illustrated as follows: 

"A fire insurance policy is a contract to indemnify the 
holder thereof for actual destruction, by a certain imme- 
diate cause, i.e., fire, of value appertaining to certain 
specified property owned by him." 

The thing to be noticed is that only actual immediate 
damage is covered by insurance; that is, damage which 
is attributable directly to the fire, or which is the immedi- 
ate result of fire. Thus a fire insurance company insuring 
a stock of merchandise would in case of loss be liable for 
the value of the property actually consumed, and also 
damage to the remaining property caused by fire, smoke, 
and the process of extinguishing the fire. It would not 
be liable, however, for any loss caused by the interruption 
or derangement of business and consequent loss of profit. 

An insurance policy is a personal contract. It does not 
follow the property, nor, properly speaking, insure it at all, 
though the language of the day gives a contrary impression. 
It is an agreement to indemnify a policy-holder for the 
loss accruing to him personally by reason of the destruction 
or damage of certain property. Accordingly, no person 
who is not the owner of the property burned, or who has 

1 By Richard M. Bissell. Lecture at Yale University, January 18, 
1904. Reprinted from pages 37-65 of the " Yale Lectures on Insur- 
ance, Fire and Miscellaneous," 1904. 

258 



NATURE OF CONTRACTS 259 

no interest in it, can be a claimant against an insurance 
company. Nor can an owner make claim on account of 
any other property than that directly mentioned or logi- 
cally implied in the policy itself. All policies, therefore, 
should clearly set forth the description of the property to 
be insured and the interest of the policy-holder therein. 
While no one can insure property unless he has a valuable 
interest therein, any kind of an interest which can be 
valued in cash may be insured. Accordingly, a man who 
loans money on a building acquires an interest in it, and 
he may insure that interest, either separately, or, as is the 
custom, in conjunction with the owner of the building, 
both interests being covered by one contract. A pur- 
chaser who has paid in part for property which he may 
not receive until full payment is made, acquires an interest 
which may be protected by insurance. A life interest 
in property, also the reversionary interest of the final 
legatee, may be insured. In fact, any tangible, valuable 
interest in any kind of property may be made the subject 
of an insurance policy. It is a maxim of the business, 
however, that the value of all such interests must not 
exceed the actual cash value of the property itself. 

In addition to the interests already mentioned, it is 
possible to insure against the loss of almost any ascer- 
tainable value which is subject to obliteration or deprecia- 
tion by fire. Thus, the rental income of a building may 
be insured by a contract which will make good the loss 
of rent during the time the building is rendered untenant- 
able by fire. So, also, in certain cases, what is called the 
use and occupancy of a manufacturing plant; that is to 
say, its ability to turn out the appropriate finished product 
in regular quantities, may be insured against interruptions 
by fire. 

The property to be insured must be definitely described. 
A policy so written as to cover a stock of boots and shoes 
will not also cover dry goods, nor will a policy insuring a 
building also insure outbuildings or awnings. The written 



260 YALE READINGS IN INSURANCE 

description forming part of every policy must either specifi- 
cally mention everything to be insured, or must be couched 
in such broad terms as to include everything for which 
protection is desired. Thus a contract insuring merchan- 
dise would protect everything kept for sale, the word 
" merchandise" being very broad in its connotation; 
whereas a contract, as above, insuring a stock of boots 
and shoes, would cover nothing else. 

In order to appreciate the relations which exist between 
a fire insurance company and the insured we must bear in 
mind the following facts, which will also indicate the 
reasons for the carefully drawn and somewhat stringent 
contracts by which insurance is undertaken. 

In the first place, property covered by insurance is not 
only for the most part in the custody of the insured, but 
is usually occupied, operated, or handled by him. More- 
over, and this is even more important, the information 
upon which the insurance is based is furnished by the 
insured, hence the obvious opportunities for fraud which 
the stringent policy conditions are intended to prevent — 
an intention which is only partially accomplished, as the 
experience of every company will demonstrate. In this 
connection a comment from a New York court will be 
appropriate : 

"In negotiating a contract of insurance the parties are 
not upon a level, nor do they deal at arm's length. The 
insurer, i.e., the company, is presumed to be ignorant, and 
the insured informed in respect to the subject to be insured. 
Hence, in forming the contract, the insurer, except he 
undertake to inquire for himself, does not rely on his own 
resources, but reposes exclusively on the intelligence 
communicated by the insured. And hence, further, the 
parties occupying this unequal position, the law exacts 
of the party holding the position of advantage — i.e., the 
insured — the utmost good faith and candor in communi- 
cating the facts affecting the risk." 

Again, Mr. Hine, in his "Book of Instruction," says: 



NATURE OF CONTRACTS 261 

"In no contract is one party more completely at the 
mercy of another than the underwriter, i.e., the company, 
in insurance. He is necessarily ignorant of facts and cir- 
cumstances that may be vital to the risk and hence open 
to the fraud of designing men, who may withhold or mis- 
represent 'material' facts." 

Some mention has already been made of the significant 
features of the earliest insurance contracts, or policies, as 
they began to be called somewhere about 1700, and did 
space permit, the history of the development of the fire 
insurance contract and its attendant clauses would well 
repay investigation and is recommended as an interesting 
and highly instructive topic for independent work for any 
who may care to pursue their studies. The present dis- 
cussion, however, must be limited for the most part to 
contracts now in general use, and the history of the develop- 
ment which leads up to them cannot even be briefly indi- 
cated here beyond the statement that the simple and brief 
policies used in the early days of insurance history have 
expanded into the lengthy and complex documents now 
in general use by gradual process of development, the 
numerous changes embodying the results of the experience 
of the intervening years. Each new clause or provision 
has a history. 

While most of the policies issued during the early years 
of the nineteenth century were similar, yet divergencies 
arose at a comparatively early date owing to changes and 
additions which resulted from the varying experiences and 
theories of different underwriters. These differences were 
increased by the efforts of those companies who strove to 
gain favor by attractive forms of contracts, also by those 
who endeavored, by cunningly worded and over-stringent 
forms, to prepare pretexts by which the payment of losses 
claimed might be avoided. This latter practice has even 
to this day characterized many contracts made attractive 
at first sight by their low prices. The swindler in fire 
insurance, as in other lines of business, endeavors to 



262 YALE READINGS IN INSURANCE 

market worthless wares by quoting prices below those 
at which valuable and reliable articles can be secured. 
Since it usually happens that more than one company 
carries insurance on the same property, the difference in 
forms of contracts above referred to often produced dis- 
pute and confusion when claims arose under them. Until 
1867, however, no great degree of uniformity was at- 
tempted. The various insurance centers, such as Boston, 
Hartford, New York, Philadelphia, and New Orleans, each 
had its characteristic form, some companies doing a widely 
extended business using various forms in different parts 
of the country. 

In 1867 and 1868 the National Board of Underwriters, 
an organization comprising most of the leading fire insur- 
ance companies of the country, and which has had a very 
important influence upon the development of the fire 
insurance business, devised and adopted a form of contract 
or policy designed to be used universally. However, few 
companies outside of the city of New York adopted the 
form in its entirety, and the annoyance to which the pub- 
lic was subjected by the varying kinds of contracts, brought 
about in 1873, in the State of Massachusetts, a law provi- 
ding for a standard form of policy, and in 1880 the Massa- 
chusetts standard policy was made obligatory upon all 
companies operating in that state. 

In 1886 the State of New York also adopted a standard 
form of policy which became mandatory January 15, 1887. 
This policy was devised by the superintendent of insur- 
ance in consultation with various eminent insurance 
officials and organizations. It was carefully prepared 
and is, on the whole, while not altogether beyond criticism, 
the most useful and satisfactory fire insurance contract yet 
brought into anything like general use. It has been made 
mandatory by seven other states, and is commonly used 
by all insurance companies doing a widely extended busi- 
ness throughout the United States wherever the laws of 
individual states do not forbid. 



NATURE OF CONTRACTS 263 

Other forms of standard policies have been adopted by 
the States of Maine, Massachusetts, New Hampshire, 
Michigan, Missouri, Virginia, and Wisconsin, but are all 
inferior to the New York form, which we will accordingly 
adopt as the basis of our discussion. The standard policy 
is a form with the conditions and stipulations printed in 
a certain size type, prescribed by law so that it may be 
plainly read. Everything is prescribed by law except the 
premium, the term, date and amount. A space is left for 
the proper description of the particular piece of property 
to be insured. 

The first part of the contract (see Chapter XII), below 
the name of the company, is the statement of the considera- 
tion. Policies, like most other contracts, are not valid 
without a valuable consideration. The important thing to 
notice here is that not only the premium paid, but also the 
printed stipulations of the policy are a part of this considera- 
tion. Next follows the name of the person or corporation to 
whom the contract is issued. Then the beginning, duration, 
and ending of the period for which the contract is to run 
are clearly stated. You will note that the contracts begin 
and end at noon. For some reasons it would be more con- 
venient to have a later hour than twelve o'clock, so that 
the policies might end at the close of a complete business 
day. Whether the language used means the solar noon, i.e., 
the moment when the sun crosses the meridian, or twelve 
o'clock according to the standard time at the particular 
place where the policy covers, is not yet definitely settled 
by the courts. Next, the policy limits the amount for 
which the company may be liable. Then comes a clause 
limiting the application of the policy to the property 
described while in the location mentioned in the policy 
only. Needless to say, the contract is made and the rate 
of premium fixed according to the hazard of the location 
of the property when insured, hence the policy must be 
confined to that location, unless altered by a new agree- 
ment between the parties to it. Next follows a space for 



264 YALE READINGS IN INSURANCE 

the description of the property to be insured; also for a 
description of its location and for any additional permits, 
stipulations or agreements (such as a permit allowing 
other insurance, or for the use of gasoline, etc.), which 
may be agreed upon by the company and the policy-holder, 
which additional agreements, however, must not be in 
conflict with the mandatory legal conditions of the policy. 
After the description follows a paragraph which defines, 
briefly and fully, the liability of the company and the 
method for settlement and payment of losses. The first 
few lines have already been anticipated, and do not need 
further comment. The latter portion of the paragraph 
states the options to which the company is entitled; (a) 
to pay to the assured the duly ascertained value of the 
property damaged, thereby acquiring ownership of it; or, 
(6) to repair, rebuild, or replace the property destroyed 
or damaged with other of like kind and quality after the 
loss or damage has been duly proved. But the assured 
is not permitted to abandon his property to the company 
except at its option. 

The first option is often useful in cases where an exces- 
sive damage is claimed on articles whose value has been 
fixed during the settlement. For instance; if the assured 
and the company have agreed that the original or sound 
value of a damaged stock was $10,000, but cannot agree 
as to the amount of damage done by fire, water, or smoke, 
it is of course perfectly fair for the company to pay to the 
assured the agreed value, namely $10,000, and then to 
dispose of the stock as best it can. Very often by this 
means controversy is avoided and the claimant satisfied 
beyond cavil, while the company escapes with the loss of 
a much smaller sum than the claimant would have been 
satisfied to accept without dispute. Where this course 
is followed the damaged articles are usually cleaned, re- 
paired, and put into the best possible condition and then 
sold. This process is called wrecking and has grown to 
be a business by itself. A number of insurance com- 



NATURE OF CONTRACTS 265 

panies have organized a company to do such work, and 
there are also private concerns which conduct renovating 
establishments, where damaged goods and wares of every 
description may be cleansed, laundered, polished, repaired, 
dyed, or put through any other process that will make them 
salable, and the salvages thus made are frequently sur- 
prisingly large. 

The second option — that which gives the company 
the privilege of replacing — is availed of by companies 
in extreme cases only. Insurance companies are not 
traders or contractors. They have no special machinery 
or opportunities for advantageous buying; in fact, are 
likely to be unable to purchase at as favorable terms as 
the assured. 

Nor if a building is to be repaired or rebuilt can the work 
be economically supervised and watched by an insurance 
company, especially if, as is likely to be the case, the loca- 
tion is at a distance from the head office of the company. 

Moreover, the requirement that the company shall 
furnish articles of like kind and quality involves certain 
risks, for it may be necessary to prove that this condition 
has been satisfied. 

A noteworthy case of this kind occurred not many years 
since in Tennessee, where the owner of a hotel which had 
been destroyed succeeded in establishing what seemed to 
the companies interested an excessively high valuation, — 
so high, in fact, that it was thought a new building like 
the old one could be erected for much less than the amount 
claimed. Accordingly, the companies elected to rebuild 
instead of paying the loss, and having called upon the 
assured for plans and specifications, proceeded to make 
contracts for the restoration of the building exactly as it 
was before the fire. It was practically impossible for the 
companies to watch every detail of the construction, but 
an easy matter for the assured, who lived where the build- 
ing was located. When the building was finished the com- 
panies tendered it to the assured in lieu of payment, but 



266 YALE READINGS IN INSURANCE 

he was able to prove — or at least did prove to the satis- 
faction of a jury — that the building was not of exactly 
the same kind and quality as the old one which had been 
destroyed. Therefore he claimed the full cash payment, 
and the court decided that the companies were liable. As 
a result, the assured received the full amount of his claim, 
with interest, and since the new building was on his land, 
he also acquired that. This was a very costly experience 
for the companies and will suffice to explain why the 
option to replace is seldom used. 

We now come to what are commonly called the condi- 
tions of the policy. 

Paragraph 3 of the policy provides for the forfeiture of 
the policy by misleading or fraudulent acts or by conceal- 
ment of material facts on the part of the assured. The 
policy is based upon the representations and statements of 
the insured and therefore it is but fair that the company 
should not be bound in a case where its contract has been 
secured by false statements, or because of the suppression 
or concealment of some material fact affecting the hazard. 
Most of the provisions in this paragraph refer to the nego- 
tiations attending the issuance of the policy. 

Paragraph 4 renders a policy, which may have been 
valid during a part of its term, void in case, during its life, 
some act of the assured, or within his knowledge, operates 
to alter materially the conditions of the property insured 
as to hazard or ownership. Since the contract is a per- 
sonal one it is obvious that a change in ownership makes 
it of no effect. Furthermore, the contract was made in 
view of the hazards existing at the time of its issuance and 
was determined in several important respects by those 
circumstances, hence a material increase of hazard cannot 
be assumed without a rearrangement of the contract — 
generally as to price, but also often as to the amount 
which the company is willing to carry. Some of the 
hazards mentioned in this paragraph, such as vacancy, 
generating of gas, storage of fire works, etc., are so danger- 



NATURE OF CONTRACTS 267 

ous that most companies will not assume or continue 
liability where they exist. All of the changes mentioned 
in this paragraph are considered to affect the hazards 
involved. It will be noticed that the saving clause 
"unless otherwise provided by agreement indorsed hereon 
or added hereto" makes it possible to alter an existing 
contract so as to permit any or all of the changes mentioned 
in the paragraph under consideration, i.e., paragraph 4, 
and as a matter of fact almost every policy does permit 
one or more of the hazards or changes prohibited in this 
paragraph. 

Paragraph 5 exempts the company from liability on 
account of fires caused by war, riot, or public authority. 
Such losses for the most part can be recovered from the 
municipality, and insurance would be a double compensa- 
tion. Moreover, such losses are by their nature extraor- 
dinary and unavoidable under prevailing conditions. 
Even the apparatus for extinguishing fire, the presence 
of which may largely have reduced the price, cannot be 
used. 

Paragraph 5 also in part exempts the company from 
losses which may be concurrent with a fire loss, but are 
not losses by fire itself. If the assured remove his goods 
endangered by fire to a place of safety, it is no more the 
province of the insurance company to protect them from 
theft than before. Often companies do pay for stolen 
articles, but only because it cannot always be determined 
whether these were burnt or purloined. So, too, when an 
explosion, as, for instance, of a boiler, is followed by fire, 
the company can be held for loss caused by fire only, and 
must be relieved from claims on account of any damage 
shown to have been caused by the explosion. The clause 
freeing companies from liability when an assured has failed 
to use reasonable means to save the property is rarely 
effective. The burden of proof is upon the company in 
such case, and it is practically impossible to establish 
beyond a doubt that the loss or damage was brought 



268 YALE READINGS IN INSURANCE 

about by the assured's neglect to use reasonable means to 
preserve and save the property. 

Paragraph 6 provides that when a building falls as the 
result of weakened foundations, or is overthrown by a 
wind storm, or some other cause, the fire insurance cover- 
ing it instantly ceases, for the reason that such a building 
at once loses its value and becomes a heap of debris. Fires 
usually start in such cases from some overthrown lamp or 
stove, but the fire burns only the debris of a building 
already destroyed, — not the building itself. 

The first lines of paragraph 7 provide that certain 
articles, not as a rule inherently valuable, but being the 
evidence of value, shall not be insured. Money and 
securities are included in this list. These articles afford 
such opportunities for fraud, can be so easily concealed, 
and the amount of them is so impossible to determine, 
except from the statement of the insured, that to insure 
them would put the company so absolutely at the mercy 
of the claimant that companies have never been willing 
to assume liability on them. 

The next lines in the paragraph refer to articles concern- 
ing which there might be some dispute as to the application 
of a policy couched in general terms, or concerning the 
value of which a difference of opinion might readily arise, 
and, in general, articles of a class which companies will 
not willingly insure unless under exceptional conditions. 
Hence it is provided that, in order that these be included 
within the scope of a policy, they must be specifically 
mentioned. They are by no means prohibited from 
insurance; in fact, they are very commonly insured. 

The last lines are intended simply to put the several 
companies who may happen to insure the same building 
under different forms of contracts on an equality as to 
certain very perishable items. 

Paragraph 8 merely emphasizes what is said in para- 
graph 3 as to certain written statements made by the as- 
sured, or assented to by him prior to the issuance of policy. 



NATURE OF CONTRACTS 269 

Paragraph 9 is inserted for the protection of the com- 
panies, because, under the common law, an insurance 
contract may be affected or altered by verbal agreement, 
and because many of the details between agents and in- 
surers must be handled by clerks. A clerk or a middle- 
man may deliver a policy, collect the premium for the 
agent of the company, or even take an order for him, but 
cannot act as authoritative agent of the company unless 
so empowered by the company in writing. Many times 
claims for special terms, privileges, etc., are based on 
alleged verbal promises of clerks or middlemen. 

Paragraph 10 simply enforces the conditions embraced 
in paragraphs 3 and 4 as to a policy renewed. In other 
words, it renews the obligation of the assured, as well as 
that of the company. 

Paragraph 11 permits either party to the contract to 
terminate it. In case the company so elects, the assured 
is allowed five days in which to secure other insurance. 
When the assured chooses to cancel, the company is per- 
mitted to retain more than the proportional fractional 
part of the original premium; that is, in case of a one year 
policy canceled at six months by the assured, the company 
is allowed to retain slightly more than one-half of the 
premium. This is because the company is compelled 
to expend a considerable part of every premium received 
in handling the record of the contract so as to comply with 
the law, and in other ways to consume at the outset a part 
of each premium in fixed charges. If it is terminated 
prior to maturity by the assured, the law holds the com- 
pany to be entitled fairly to recover those fixed charges. 
If the company chooses to cancel, however, these charges 
are lost, and the assured receives full return premium 
according to the time which the policy has run. Hence, 
contracts are seldom terminated by companies without 
good cause. 

Paragraph 12 refers exclusively to mortgage interests, 
and provides that, as to such interest, companies may alter 



270 YALE READINGS IN INSURANCE 

the policy conditions as they see fit. There is some plausi- 
ble reason for this, since mortgages based upon the value 
of destructible property must be protected, and it is also 
necessary that such protection shall not be jeopardized 
by some improper action of the borrower, i.e., the property 
owner. 

Paragraph 13 simply provides that the efforts of the 
assured to save his property from destruction by removing 
it from danger shall not result to his harm. Ordinarily a 
removal without the consent of the company vitiates the 
policy and this paragraph simply makes an exception to 
this rule. 

Paragraph 14 states very clearly the duties of the assured 
if fire occurs, and provides, first, — that he shall give the 
company due notice of its occurrence. 

Second, — that he shall protect the property saved, 
whether damaged or undamaged, — at the same time 
making an inventory of the same, with complete statement 
of quantities, values, and amount of claimed damages. 
And, 

Third, — that he shall, within sixty days, render a com- 
plete statement, under oath, giving in detail a full account 
of the fire and a description of the property involved, and 
of the facts concerning its ownership, in accordance with 
the list to be found in the paragraph under discussion. 

The next paragraph gives to the company the oppor- 
tunity to inspect all that remains of the property, to cross- 
examine the assured as to claims and statements made, 
and to verify same by an examination of the books and 
records of the assured. 

It will be seen that these provisions and requirements 
contemplate the making of a complete proof or statement 
by the claimant, which the company may thereupon verify, 
test, and pass upon, and, if the proofs set forth a claim 
which is satisfactory and correct under the terms and scope 
of the contract, it is to be presumed the company will, 
at the proper time, pay it. 



NATURE OF CONTRACTS 271 

Paragraph 18 is very important. It provides for the 
distribution of loss among the various companies insuring 
identical property, according to the amount which each 
company carries. For instance, if there is $20,000 total 
insurance actually in force on any piece of property and 
one company carries $5000 of this amount, that company 
must pay and must pay only one-quarter of any loss 
occurring to the property up to the amount for which it is 
liable; and this condition is valid even if one or more of 
the other companies carrying the same risk are unable 
to satisfy the claims against them, for the amount of 
insurance legally in force determines the amount of various 
liabilities and claims. The collection of those claims is a 
subsequent operation. 

The paragraph permits special agreements between 
assured and companies as to how policies shall apply. 
There are several of these agreements in common use, 
which will be described later in this lecture. 

The last lines only apply where one insurance company 
assumes a portion of the liability of another company, and 
permit such contracts between companies to be arranged 
according to the desires of the two companies. This 
standard form of policy is intended to secure fair and 
proper conditions between companies and property owners, 
and such contracts between companies as reinsurances, 
so-called, are hardly within its purview. 

Paragraph 19 is intended, first, to prevent double com- 
pensation; that is, a profit to the insured, from a fire; 
second, to compel those through whose act or neglect the 
loss occurred to make good the loss they have caused. 
Public policy as well as equity demands this. It is mani- 
fest that I should not be made free of financial responsi- 
bility for my criminal or careless act simply because the 
person I have injured is insured. In such cases companies 
commonly pay the loss and then endeavor to collect from 
the person or corporation responsible for the occurrence 
of the loss, the amount so paid. 



272 YALE READINGS IN INSURANCE 

Paragraph 20 is a statute of limitation to guard against 
wilful and vexatious delays in making claims. 

Paragraph 21 is merely explanatory. 

Paragraph 22 is intended for mutual companies only, 
and in effect makes the articles of association of such com- 
panies a part of the policy. 

The remaining paragraph of the policy recites that no 
conditions of the policy may be altered except those whose 
language provides for modification, and that no permissible 
alteration may be made except by written endorsement on 
the policy. It will be seen that the whole purpose of the 
contract is to define the rights of the two parties interested 
so clearly and fairly that disputes may be avoided and in- 
justice or improper claims prevented. Despite the care 
exercised by its framers to this end, however, there is 
hardly a clause in the standard form which has not been 
referred to some court for authoritative interpretation, 
and a mass of legal decisions have accumulated which in 
reality are collateral to the contract and might even with 
propriety be deemed a part of it. With these decisions, 
curious and interesting as many of them are, we shall not 
concern ourselves here, the broad outlines of the contract 
being sufficient for our purpose. 

Despite the apparently stringent conditions and techni- 
cal exceptions contained in this contract, and although 
these conditions and exceptions are sometimes made the 
basis of improper attempts to avoid payment of losses by 
unscrupulous companies, there can be no doubt that on 
the whole and in by far the greater number of cases, in 
fact almost universally, the assured secures absolute 
justice, and more, from the operation of this form of con- 
tract. A very liberal estimate of the amount of litigation 
under fire insurance policies indicates that not over one- 
half of 1 per cent, of claims result in law suits. When it 
is remembered that these claims are, in 90 per cent, of the 
cases occurring, for partial damage to property, concerning 
which there is legitimate opportunity for an honest dif- 



NATURE OF CONTRACTS 273 

ference of opinion, and in view of the fact that the validity, 
as well as the amount of all claims must be established 
before payment, the amount of ensuing litigations is seen 
to be absolutely inconsiderable. Not so in effect, how- 
ever, for such is human nature that one resisted claim 
overbalances in public estimation a hundred which have 
been settled not only without friction, but even with 
liberality. 

As we have seen, there are various portions of the policy 
which may be modified by special written agreements with 
the assured, called endorsements. Any of the numerous 
prohibitive clauses in paragraph 4 may be waived in this 
way. So also with the excepted articles noted in para- 
graph 5. The most important alterations in the contract, 
however, and those most generally in use are the ones 
which refer to interests of mortgagees and those which, 
as per paragraph 18, concern the extent of the application 
of the policy or its measure of contribution. The policy 
provides that, as to the creditor's interest, the contract 
shall apply as may be expressed in the written clause 
referring thereto. The ordinary way of recognizing a 
mortgagee's or creditor's interest is to issue the policy 
to the owner and then endorse upon it "loss, if any, under 
this policy payable to John Smith, mortgagee, as his 
interest may appear." When a loss occurs under a policy 
with this clause the amount of it is settled with the owner, 
but payment must be first made to the payee, i.e., the 
mortgagee, until his interest is satisfied, or unless he con- 
sents to allow payment to the owner, as he usually will 
do when the loss is small. Since, however, many loaners 
need and demand absolute security, it is a very common 
practice to attach a printed mortgage clause which reads 
as follows: 

"Loss or damage, if any, under this policy, shall be pay- 
able to as mortgagee [or trus- 
tee], as interest may appear, and this insurance, as to the 
interest of the mortgagee [or trustee] only therein, shall 



274 YALE READINGS IN INSURANCE 

not be invalidated by any act or neglect of the mortgagor 
or owner of the within described property, nor by any 
foreclosure or other proceedings or notice of sale relating 
to the property, nor by any change in the title or ownership 
of the property, nor by the occupation of the premises for 
purposes more hazardous than are permitted by this 
policy; Provided, that in case the mortgagor or owner 
shall neglect to pay any premium due under this policy, 
the mortgagee [or trustee] shall, on demand, pay the 
same. 

"Provided also, that the mortgagee [or trustee] shall 
notify this company of any change of ownership or occu- 
pancy or increase of hazard which shall come to the knowl- 
edge of said mortgagee [or trustee] and, unless permitted 
by this policy, it shall be noted thereon and the mortgagee 
[or trustee] shall, on demand, pay the premium for such 
increased hazard for the term of the use thereof; otherwise 
this policy shall be null and void." 

This clause practically waives all rights of the insurance 
company as far as the payee is concerned. He may collect 
his due, even if it can be proven that the owner, that is, 
the assured, has fired the property himself, or if he has 
violated every condition of the policy. The only protec- 
tion for the insurance company in those cases where the 
policy itself has been made void, but where nevertheless 
payment must be made to the creditor, is a provision 
that the claim of the creditor becomes the property of the 
insurance company and may be enforced by it against the 
debtor if collectible. This right of subrogation, as it is 
called, is frequently taken advantage of by companies 
and in some instances enables them to recover a loss which 
they have paid under such conditions. The mortgage 
clause also imposes certain responsibilities upon the mort- 
gagee in case violations of policy conditions occur with 
his knowledge. 

The clauses referring to the extent of the application or 
contribution of the policy are more difficult to explain 



NATURE OF CONTRACTS 275 

briefly or to be comprehended readily. Before discussing 
those clauses at all, it may be helpful to make a few pre- 
liminary observations. 

Where there is little or no protection against fire, that 
is, no local means of extinguishing fires, as in the case of 
village stores or shops, or where, for any other reason, the 
property to be insured is thought to be subject to great 
or total loss should a fire once start, the interest of the 
insurance companies leads them to limit the amount of 
insurance (as compared with the value of the property 
insured) which may be carried or recovered in event of loss. 
This is done in order that the interest of the owner in pre- 
serving the property may be so strong that the utmost 
watchfulness and careful attention will be observed by 
him. It is evident if, in the event of fire, he is likely to 
suffer a severe loss over and above his insurance, he will 
have a much stronger incentive to guard his property from 
fire than if it were insured for its full value. For a similar 
purpose companies find it necessary to limit the percentage 
of insurance to be carried in certain states or districts 
where conspicuous or abnormally heavy burning ratios 
indicate unusual carelessness, unsatisfactory protection, 
or dangerous methods of construction. In other words, 
the greater the danger of total loss the stronger pecuniary 
interest the owner should have in the preservation of his 
property. On the other hand, where there is efficient fire 
protection, as in most large cities, or where a policy covers 
in several distinct locations, or on property which is not 
readily susceptible to damage, as for instance, bar iron, 
there is a reasonable prospect that fires will be extinguished 
before a large portion of the property involved is de- 
stroyed. In such cases, therefore, insurance companies 
naturally desire that a large proportion of the value should 
be covered by insurance in order that a moderate loss of 
property shall cause only a moderate loss to the insurance 
company. In the unprotected village any loss is likely to 
be a total one. In the protected city almost all losses are 



276 YALE READINGS IN INSURANCE 

partial, and insurance companies try to adapt their methods 
to the varying conditions. 

Where it is desired to limit the amount of insurance, the 
New York law permits the use of the clause known as the 
" percentage value clause." This prevents the assured from 
recovering more than a certain, usually 75 per cent, of the 
value of the property insured. If by mistake he has been 
carrying insurance exceeding that amount, he is entitled 
to a return of the premium paid on the excess over the 
percentage which the clause fixes as a limit to recovery. 

However, by far the greater amount of insurable property 
is located under more or less efficient fire protection and 
consequently the limitation clauses are not used, but in- 
stead, where possible — for in some states the law stands 
in the way — what is commonly known as the co-insurance 
clause is used, which reads: 

"It is a part of the consideration of this policy, and the 
basis upon which the rate of premium is fixed, that the 
assured shall maintain insurance on each item of property 
insured by this policy, of not less than 80 per cent, of the 
actual cash value thereof, and that, failing so to do, the 
assured shall be an insurer to the extent of such deficit, 
and in that event shall bear his, her, or their proportion 
of any loss." 

It provides in the words of Mr. F. C. Moore, "that 
whatever percentage of the property is destroyed — one- 
quarter, one-half, or three-quarters, as the case may be — 
that percentage of the insurance is payable"; or, as Mr. E. 
F. Beddall states the case, "it (the clause) leaves the 
insured free to carry as much or as little insurance as he 
deems needful, but it fixes the proportion of the loss re- 
coverable from the company in the event of fire, to such 
as the assured has chosen to pay for. If he insures for 
one-half of the value he recovers one-half of the loss, be 
it partial or total; if the whole of the value, the whole of 
the loss. There is, there can be, no inequity in this." 

Still another statement of its effect may be made as 



NATURE OF CONTRACTS 277 

follows: In order that the assured may secure indemnity 
for the whole of any large or small loss he may sustain, he 
must carry insurance equal to the full value of the property 
involved. Usually a percentage co-insurance clause is 
used, which makes some given per cent, of the value of the 
property, ordinarily 80 per cent., the amount which the 
insured must carry in order to secure in all cases full 
benefit of his insurance. Failing so to do, he can recover 
only such proportion of any loss amounting to less than 
80 per cent, of the value of the property insured, as the 
amount of insurance he actually carries bears to 80 per 
cent, of the value. Thus, if the value is $10,000 and the 
insurance $5000, he can recover but five-eighths of any 
loss which amounts to less than $8000; that is, of any loss 
which amounts to less than 80 per cent, of the $10,000. 
When, however, the assured carries insurance equal to 
80 per cent, of the value of the property covered, the 80 
per cent, co-insurance clause is of no effect. The assured 
in such cases will receive the entire amount of his loss, be 
it large or small, not exceeding, of course, the amount of 
the policy. This should be carefully noted, for many 
people labor under the impression that where such a clause 
is used only 80 per cent, of any loss can be collected. 

The co-insurance clause is even more important as a 
factor in the problem of making rates or prices, as we shall 
see when discussing that subject. Where this clause is 
used in a policy a reduction in price is made as compared 
with policies covering similar property similarly located, 
but without the co-insurance clause. In fact, this clause 
is often called the reduced rate clause in states where the 
law has not given it a name. 

In some parts of the country, for instance Indian Terri- 
tory, Texas, and Arkansas, where fires have occurred with 
abnormal frequency, and particularly on certain classes 
in those sections, such as cotton-gins, which are extremely 
liable to fire on account of the inflammable nature of the 
cotton and the process to which it is subjected, the per- 



278 YALE READINGS IN INSURANCE 

centage value clause is sometimes replaced by what is 
known as the "three-quarters loss clause," which reads 
as follows: 

"It is understood and agreed to be a condition of this 
insurance, that in the event of loss or damage by fire to 
the property insured under this policy, this company 
shall not be liable for an amount greater than three-fourths 
of the actual cash value of each item of property insured 
by this policy (not exceeding the amount insured on each 
such item) at the time immediately preceding such loss or 
damage, and in the event of additional insurance — if any 
is permitted hereon — then this company shall be liable 
for its proportion only of three-fourths such cash value 
of each item insured at the time of the fire, not exceeding 
the amount insured on each such item." 

This clause provides that the property owner shall suffer 
one-quarter of any loss, great or small, which may occur 
to his property. This, of course, is used for the same 
reasons that prompt the use of the percentage value 
clause, but is much more radical. And, as a further pre- 
caution, there is embraced in policies covering mercantile 
and manufacturing property in states with a bad fire his- 
tory, clauses making the policies void unless the assured 
shall keep an accurate set of books, take an annual inven- 
tory, and either keep both books and inventory in a fire- 
proof safe, or in a place where they will not be endangered 
by fire in a building where insurance covers. This clause 
is known as the "iron-safe clause," of which a copy is 
as follows: 

" The following covenant and warranty is hereby made 
a part of this policy: 

" First. — The assured will take a complete itemized 
inventory of stock on hand at least once in each calendar 
year, and unless such inventory has been taken within 
twelve calendar months prior to the date of this policy, 
one shall be taken in detail within 30 days of issuance of 
this policy, or this policy shall be null and void from such 



NATURE OF CONTRACTS 279 

date, and upon demand of the assured the unearned pre- 
mium from such date shall be returned. 

" Second. — The assured will keep a set of books, which 
shall clearly and plainly present a complete record of 
business transacted, including all purchases, sales, and 
shipments, both for cash and credit, from date of inventory 
as provided for in first section of this clause, and during 
the continuance of this policy. 

" Third. — The assured will keep such books and inven- 
tory, and also the last preceding inventory, if such has 
been taken, securely locked in a fire-proof safe at night, 
and at all times when the building mentioned in this 
policy is not actually open for business; or, failing in this, 
the assured will keep such books and inventories in some 
place not exposed to a fire which would destroy the afore- 
said building. 

" In the event of failure to produce such set of books and 
inventories for the inspection of this company, this policy 
shall become null and void, and such failure shall constitute 
a perpetual bar to any recovery thereon." 

This clause is intended to bar out from the protection 
of insurance policies the shiftless and careless dealers and 
manufacturers who abound in many of the smaller towns, 
especially in the Southwest. It also insures a more satis- 
factory and intelligent loss settlement, should a loss occur, 
than is possible in those cases where the entire property 
is destroyed and no record of quantities or of transactions 
is preserved. 

Still another clause used to govern the application of the 
policy is one known as the distribution average clause, 
which reads: 

" It is understood and agreed that the amount insured by 
this policy shall attach in each of the above-named prem- 
ises in that proportion of the amount hereby insured that 
the value of property covered by this policy contained 
in each of said places shall bear to the value of such prop- 
erty contained in all of above-named premises." 



280 YALE READINGS IN INSURANCE 

This clause provides that the amount of insurance shall 
attach in each of two or more locations according to the 
value in each. For instance, a merchant may have his 
merchandise in three locations — in his store where it is 
to be sold; in his warehouse, where he keeps a surplus 
stock, and in the freight depot of the railway or steamship 
line by which he receives it. As business progresses his 
merchandise is constantly shifted. One day two- thirds 
will be in his store; on another day one-half in his ware- 
house; on still other days he may have none at all in the 
freight depot. If he insures his stock under a policy with 
the distribution average clause, the policy will automati- 
cally divide itself as the stock is divided from day to 
day. If one-third of the value is in the warehouse so will 
one-third of the policy cover there. If the warehouse is 
empty the policy will apply only in the store and freight- 
house. And also that part of the policy which covers 
at each location will be equal to the fraction of the total 
value of the property at each location. 

Various other clauses are used by companies to further 
the convenience of different patrons, or to provide against 
the contingencies which arise in different parts of the coun- 
try, but the foregoing are the principal clauses, the others 
being more seldom used. 

Policies are said to be specific when they cover on one 
kind of property or in one definite location; floating when 
they cover under one division property located at a num- 
ber of different locations; general when they cover several 
kinds of property under different items at one location; 
concurrent when they agree exactly as to their wording 
and as to the kind of property covered; perpetual when 
their duration is without limit, except by cancelation. 

These perpetual policies originated in Philadelphia, 
where they are chiefly, if not solely, used. It will be 
remembered that one of the earliest companies issued poli- 
cies for seven years in consideration of a deposit by the 
assured, and that the deposit was to be returned to the 



NATURE OF CONTRACTS 281 

assured at the expiration of the policy. It was a very 
natural process to agree with the assured to retain this 
deposit indefinitely, thus extending the term of the insur- 
ance and making it perpetual. 

As we have seen heretofore, eight other states have 
prescribed the New York standard policy, and again, seven 
states have adopted standard policy forms of their own, 
each differing from the other and all from the New York 
form. It follows that every company which does a widely 
extended business must keep in stock at least eight different 
kinds of policies. Moreover, since some of the states per- 
mit any form of endorsement clause which does not conflict 
with the policy in use in that state, while others, like New 
York, permit only clauses which have been specifically 
authorized by law or passed upon by the insurance official 
of the state, it will be seen that companies are compelled 
to have and use a very great number of different clauses. 
In fact, it requires a very considerable amount of study 
and a good memory for any one person to be able to keep 
in touch with the widely differing state requirements as to 
policy forms and their attendant clauses. Such unneces- 
sarily and often injuriously divergent laws entail great 
expense and labor on the companies, and neither they nor 
the insuring public benefit therefrom. It cannot be 
doubted that one simple form of policy and one set of 
appropriate clauses would be better for all concerned. 



CHAPTER XIV 

THE CO-INSURANCE CLAUSE 



It has always been a condition of marine insurance, as 
it should always have been a condition of fire insurance, 
that the principle of average or co-insurance should apply 
in determining the amount to be paid in case of loss. It 
would be as unjust to insure the properties of two owners 
at the same rate, the one insuring for 50 per cent, and the 
other for 100 per cent., as to assess the values of their 
properties for the purposes of municipal or state taxation 
on different percentages of value. 

The old French co-insurance clause read as follows: 

"If, at the time of the fire, the value of the objects 
covered by the policy is found to exceed the sum total 
of the insurance, the assured is considered as having 
remained his own insurer for that excess, and he is to bear, 
in that character, his proportion of the loss." 

The German clause was as follows: 

"If, in case of loss, the insured objects should exceed 
the sum insured, and they should be partly saved, the 
assured will be considered as self-insurer for the excess, 
and is to bear his share of the loss pro rata." 

These two clauses met the issue squarely and left no 
room for mistake as to what was intended; but after the 
slipshod American methods of nearly a century of insur- 
ance it is doubtful if the use of these clauses, which were 

*By Francis C. Moore. Reprinted from pages 573-580 of "Fire 
Insurance and How to Build"; The Baker and Taylor Company. 
New York, 1903. 

282 



THE CO-INSURANCE CLAUSE 283 

perfectly proper and straightforward, would be accepted 
without the criticism of placing a portion of the burden 
of insurance upon the policy-holder, overlooking the fact 
that if his rate is graded according to the amount that he 
carries, there is no more reason why he should complain 
than in the case of goods purchased at retail as compared 
with wholesale prices. 

The following is the form of the co-insurance clause of 
New York State. 

"This company shall not be liable for a greater proportion 
of any loss or damage to the property described herein 
than the sum hereby insured bears to . . . per cent. 
(. . . per cent.) of the actual cash value of said property 
at the time such loss shall happen. 

"If the insurance under this policy be divided into two 
or more items this clause shall apply to each item sepa- 
rately." 

The following is a clever illustration of the fairness of 
co-insurance : 

To write a blanket policy upon large manufacturing 
plants which are composed of divers risks without the 
co-insurance clause is the equivalent of assessing a tax on 
your largest buildings at 30 per cent, of their value, while 
all other property in the city is assessed at 60 per cent. 
This discrimination, if made by your tax assessor, would 
be promptly corrected by the board of equalization; and 
yet by a singular paradox, legislators, who are insisting 
upon an equitable and equal assessment and collection of 
the fire tax, have attempted in some states to force us 
to tax the poor man at double the rate that we tax the 
rich corporation. To show you how necessary it is to 
collect a tax based upon about approximately 80 per cent, 
of the value of the properties, I will use an illustration 
which the insurance gentlemen present will understand, 
and which I hope will be perfectly clear to the laymen 
present. 

Take 1000 detached frame dwellings worth $1200 each, 



284 YALE READINGS IN INSURANCE 

and insured at $1000 each. The premiums at 1 per cent, 
would be $10,000. Experience in this South Texas field 
demonstrates that the loss would be approximately $6000, 
or 60 per cent, of the premiums. Going further into 
detail, the underwriter who is making the rates finds that 
at least 60 per cent, of this total amount comes from 
trifling losses that range from $1.00 to $150; that there 
will be two or three losses where the damage will be prac- 
tically 50 per cent., or $500 each, and two losses where we 
will say the losses are total, $1000 each. We then have 
the figures: 

2 total losses of $1000 each $2000 

2 losses of 50 per cent., $500 each 1000 

50 losses in small amounts from $1 to $150 3000 

Now then let us suppose that some underwriter new to 
the business has entered the field, and has an opportunity 
to scoop these 1000 good detached dwellings. The owner 
has found out that most of his losses are small, and he 
concludes to take a small amount of insurance and no 
co-insurance. The tyro in the business takes $500 insur- 
ance on each one of these 1000 dwellings at the same rate, 
1 per cent., which would make his premium $5000. The 
losses are the same as before. Let us see where each one 
of the underwriters will find himself. The figures in the 
last case would be as follows: 

2 total losses, $500 $1000 

2 damage losses of $500 each (but as the policies are 
for only $500 each there are two total losses to the 

company under these policies 1000 

50 losses same as in first example, being for small 
amounts 3000 

Total losses paid $5000 

The result of this brilliant feat of underwriting, in which 
the underwriter insures only one-half the value of the 
property without co-insurance, will be premiums $5000, 



THE CO-INSURANCE CLAUSE 285 

losses to the insurance company $5000, and it is minus 
its expenses, which at 35 per cent, would amount to 
$1750. The company writing without the co-insurance 
clause, or at half value, has made a loss of $1750 or about 
35 per cent., but this loss does not fall upon the company. 
Every company recoups its losses by an increased assess- 
ment of tax in some other direction, and the result is that 
the neighbors of the man who had these 1000 dwellings 
are assessed to pay the $1750 losses made in handling his 
business, together with a small profit which is needed for 
the company to continue in business. Is it fair to the 
owners of property throughout the state, who have been 
mulcted to pay the loss on this individual because he was 
improperly assessed? 

The following illustration of President Evans of the 
Continental also shows how unfair is a policy, without the 
co-insurance clause, issued at the same rate as one contain- 
ing the clause. 

A and B each own a half interest in a building having a 
present structure value of $20,000. Each insures his half 
interest separately and in different companies; each com- 
pany charges the same percentage or "rate" for insuring 
the property, and that "rate" is 1 per cent, or $10 for 
$1000 of insurance. A insures his half in the Y com- 
pany for $10,000 and pays for his policy $100. B insures 
his half in the Z company for $5000 and pays for his policy 
$50. A fire occurs and the building is damaged $10,000 
only. Company Y, insuring A, is called on to pay but 50 
per cent, of the amount of its policy, while company Z 
pays 100 per cent.; and yet company Y received twice 
o as much premium as did company Z. 

It is sometimes impossible for the owner of property of 
a movable character, changing its location from day to 
day, and often from hour to hour in each day, as in the 
case, for example, of the product of a paper-mill, which 
in the morning may be in the paper-machines at one end 
of the mill and by evening in the dryhouse, to accept 



286 YALE READINGS IN INSURANCE 

insurance covering specifically. Under such circumstances 
the distribution form of the average clause may be used, 
which practically secures specific insurance in that pro- 
portion which the insured would fix at the moment of a 
fire, if he knew the value in each location. In short, the 
policy applies for such proportion of its amount in any one 
location as the value in such location bears to the value 
in all locations. 

Of course, the full co-insurance clause, the insurance 
being equal in amount to the value of all of the property, 
no matter where located, would take care of the interest 
both of the assured and of the company, but the property 
owner is not always willing to have a full co-insurance 
clause, and under the mistaken legislation of some states 
the use of any average or co-insurance clause is prohibited. 
The full co-insurance clause provides that whatever 
fraction or percentage of the value is destroyed that frac- 
tion of the insurance is payable. If one-half the value 
is insured one-half the loss is collectible from the insurance 
company. If the whole value is destroyed the whole 
insurance is collectible. 

Let us suppose a merchant having goods stored in two 
different warehouses, A and B, so located relatively that 
they could not burn by one and the same fire. In A 
he has $6000 and in B $3000. If he should take out a 
policy of $6000 covering in both, without specific amounts 
and without the average clause, it is clear that the policy 
would effectually protect him, since a loss in either build- 
ing would be covered by his insurance, and hence an insur- 
ance of $6000 would be almost as effectual as an insurance 
of $9000 written specifically, the only chance of his losing 
more than $6000 being in case both buildings should 
happen to burn at the same time. Any intelligent under- 
writer would decline to issue such a policy except at double 
rate; but if the merchant should claim that he could not 
tell at any one time just what proportion of value would 
be in each warehouse and for that reason alone could not 



THE CO-INSURANCE CLAUSE 287 

insure specifically, and is unwilling to pay for insurance 
in excess of two-thirds of the value, the "distribution 
form" of the average clause would adjust the matter so 
that the policy would cover in each in proportion as its 
value should bear to that in both. This would be better 
than a specific policy for his purpose and equally as fair 
for the underwriter, since its effect would be to distribute 
the insurance at the time of the happening of a fire so as 
to cover or apply in each warehouse in the proportion 
that the value in such warehouse bears to the value in 
both. The insurance on this plan is thus made to follow 
the value, no matter how often it fluctuates. 

Let us suppose the values, then, are $6000 in A and 
$3000 in B and that a fire occurs doing a damage in 
A of $4000; as the insurance covers in this building 
in the proportion that its value ($6000) bears to the value 
in both ($9000), two-thirds of the insurance, or $4000 
would attach in A and in this case be sufficient to pay 
the loss. 

Under the full co-insurance clause, by which the policy 
pays that proportion of the loss that the whole insurance 
($6000) bears to the whole value of the property ($9000), 
or two-thirds, the owner would only receive two-thirds of 
his loss of $4000, or $2666.66 

If instead of the full co-insurance clause, the 80 per cent, 
co-insurance clause is used, the policy for $6000 would pay 
such proportion of the loss, $4000, that $6000 bears to 
$7200 (80 per cent, of $9000) or five-sixths of it, i.e., 
$3333.33. 

II 1 

Two vital questions confront the fire insurance company 
with every policy it issues: 1. Is the property insured for 

1 By A. F. Dean. Reprinted from pages 119-125 of "The Rationale 
of Fire Rates"; J. M. Murphy. Chicago, 1901. 



288 YALE READINGS IN INSURANCE 

too great a proportion of its value? 2. Is it insured for 
too small a porportion of its value? 

In the first instance the owner may become indifferent 
to the care of his property, or even have a direct incentive 
to destroy it by fire. 

In the second instance the company does not receive 
sufficient compensation for the risk it assumes, and the 
owner secures more indemnity than he pays for, thus 
obtaining an advantage over other people who pay for 
what they get. 

The problem of securing a uniform relation between 
insurance and value confronts every company in the 
acceptance of every risk; for it is an established principle 
in fire underwriting that rates cannot be made intelligently 
and fairly except on the theory that all property is insured 
for about the same proportion of its value. It makes no 
difference what this proportion be if everybody be insured 
for the same proportion. If all property were insured for 
only one-fourth of its value, statistical experience would 
soon reveal the proper rate for property insured for one- 
fourth value; but if one man has his property insured for 
one-fourth its value, and another for three-fourths, the 
former may receive as much indemnity in the event of 
partial loss as the latter, who paid three times as much 
for his insurance. 

It is impossible for the company or its agent, or even 
the owner himself, to estimate closely the value of prop- 
erty, and even if it could be estimated, values are con- 
stantly fluctuating. The only way to adjust the matter 
to ensure equity to all concerned must be through a mutual 
agreement that if the property is not insured for a stipu- 
lated proportion of its value at the time of the fire, the 
assured shall be a co-insurer for the deficit. 

This simple plan of adjusting a difficult problem is so 
fair that the use of the co-insurance clause is world-wide. 
In France, Italy, Spain, Portugal, Belgium, and the 
Rhenish Provinces, the co-insurance clause is required by 



THE CO-INSURANCE CLAUSE 289 

law, and in other parts of Europe the agreement is invari- 
ably made a part of the policy contract. 

It is singular that what is obligatory throughout Europe 
is prohibited in this country by law. At the present time 
ten prominent states of the Union forbid the use of the 
co-insurance clause. The only explanation ever given for 
this prohibition of co-insurance is that it encourages over- 
insurance, but many of the states, while prohibiting 
co-insurance on this ground, have enacted a valued-policy 
law which offers an incentive for people to over-insure 
their property. Besides, a co-insurance clause that makes 
the agreed proportion between the insurance and value 
80 or 90 per cent, does not encourage over-insurance. 

Aside from the mathematical necessity for a uniform 
relation of insurance to value in establishing equitable 
rates, co-insurance is the safeguard that protects small 
property owners from the cunning devices of large cor- 
porations in their efforts to avoid the payment of their 
share of the fire tax. If the facts could be once under- 
stood, there would be not only a popular demand for the 
repeal of all laws prohibiting co-insurance, but a demand 
for the enactment of the European laws which make 
co-insurance obligatory; because the European laws ensure 
a just distribution of rates, while the American laws put 
it in the power of the propertied interests to unload a share 
of their fire tax upon people of small means. The evasion 
of the fire tax in this way is no less notorious or unjust 
than the evasion of state and municipal taxes. It is 
difficult to make this plain to one not versed in fire insur- 
ance. In fact, the vital bearings of co-insurance on rates 
are not appreciated by the majority of fire underwriters. 
The importance of the subject, however, justifies the follow- 
ing explanation: 

It should be borne in mind that but a small proportion 
of fire losses are total. Out of twenty claims made against 
the companies, on a low estimate nineteen are partial 
losses, ranging from a merely nominal damage up to the 



290 YALE READINGS IN INSURANCE 

nearly full value of the property. This average of partial 
losses is enormously increased when the property insured 
is not all subject to one fire. In nearly all large whole- 
sale and manufacturing establishments the contents are 
located in different compartments, which are separated 
by brick walls with fire-proof doors and shutters over 
every opening. Sometimes the property is located in a 
number of different buildings. When a fire starts in one 
compartment or building, the fire department, in ninety- 
nine cases out of a hundred, is able to confine it to that 
compartment or building, so that in establishments of 
this kind a total loss seldom or never occurs. 

The practice in American fire underwriting, up to about 
fifteen years ago, was to require a specific amount of in- 
surance upon every building, and when a building was 
divided by solid brick walls with fire-proof doors, a sepa- 
rate amount of insurance was required to be placed on 
and in each compartment. 

The reason for this was, that if the insurance were 
spread to cover the entire establishment in one item of 
insurance, the owners would need only enough insurance 
to cover the value in one compartment or building, as this 
would be enough to cover all possible loss. The equity 
of the regulation regarding specific insurance was so plain 
that large merchants and manufacturers could not reason- 
ably object to it, and specific insurance was the rule 
throughout the country, but it was found that specific 
insurance worked an injustice to property owners in one 
respect. The owner knew, at least approximately, how 
much insurance he needed on each building, but it was 
impossible for him to tell how much he needed on the con- 
tents of each building. If a mercantile stock, the value 
in each compartment or building was constantly changing, 
and he could not keep his books to show the value in each 
compartment; if a manufacturing plant, the property in 
process of manufacture was constantly shifting from one 
part of the establishment to another, and it was impos- 



THE CO-INSURANCE CLAUSE 291 

sible to estimate from the books the value of the property 
in any one building or compartment. Wholesale mer- 
chants and large manufacturers of all kinds began to insist 
that they must have their insurance arranged to cover 
any part of their establishment where fire might occur. 
The companies then proposed to issue policies under a 
blanket form (that is, covering the entire property in 
one sum), provided the assured would agree to keep the 
property insured for 80 per cent, of its value, and if the 
insurance at the time of the fire should be less than that 
proportion, the insured should be a co-insurer for the 
difference between the amount of insurance and 80 per 
cent, of value. 

People readily accepted this equitable arrangement, 
which relieved them from the care of constantly watch- 
ing values in each compartment to see that the insurance 
was adequate. In a short time blanket policies with the 
co-insurance clause came into general use, and all the large 
commercial and manufacturing establishments of the 
country were insured under what became known as "the 
blanket form, with co-insurance." 

In time some schemer discovered that if he could get 
the co-insurance clause declared illegal, it would be pos- 
sible to reduce his insurance materially, without impairing 
the protection afforded by his blanket policy form. To 
offer any bill that seems mimical to fire insurance is to 
ensure its enactment in many states, and the anti-co-in- 
surance law has been spreading ever since under the active 
encouragement of interested property owners. 

This law, coupled with the law forbidding tariff rates, 
creates a condition in fire insurance as absurd as if the 
state, which requires its tax officials to take oath that they 
will spread taxes equitably, should at the same time for- 
bid them to fix a uniform tax percentage, or to establish 
property valuations. 

The concession of blanket insurance was obtained on 
the condition of co-insurance; now the great trusts of the 



292 YALE READINGS IN INSURANCE 

country are claiming the benefits of blanket insurance 
without co-insurance. Under the anti-co-insurance law 
there has been a constant reduction of insurance to value 
on every risk insured under a blanket form, and it is well 
within bounds to say that, in the aggregate, such risks are 
not insured for over 40 per cent, of value, and the owners 
are securing their fire indemnity for about half what they 
would have to pay for protection under a specific form, 
thus securing their insurance at an advantage over people 
of small means whose property is usually located in one 
building, and subject to total destruction by a single fire. 

Co-insurance was not required when insuring dwellings, 
stores, schools, public buildings, or other similar property. 
There are thousands of towns throughout the country 
where the clause was never heard of, and where the people 
have no direct interest in the subject ; but indirectly every 
small property owner is interested, because the prohibition 
of co-insurance benefits no one but the great concerns 
whose distributed property is usually located in cities, or 
under the protection of private fire departments. Blanket 
insurance enables these concerns to evade their just share 
of the insurance tax at the expense of the community at 
large, because a corresponding increase is made in the loss 
ratio shown by the statistics upon which rates are estab- 
lished. 

It is proper to add that the principle of co-insurance 
has always been applied to marine insurance, though the 
reasons are not so logical as in fire insurance, because in 
the marine risk the property is all exposed to loss, while 
in a large proportion of fire risks the property is so dis- 
tributed that it is not subject to total loss. No explana- 
tion has ever been given why our laws permit the universal 
use of co-insurance in marine insurance while prohibiting 
it, with severe penalties, in fire insurance. 1 

*At the present time, laws forbidding the use of the co-insurance 
clause are in force in Georgia, Indiana, Iowa, Louisiana, Michigan, 
Minnesota, Missouri, Ohio, Tennessee and Wisconsin. 



CHAPTER XV 

VALUED-POLICY LAWS 



[In 1874 Wisconsin enacted] a statute, since known as 
the valued-policy law, which declared that whenever an 
insured building should be totally destroyed by fire, the 
amount of insurance in force should be taken as conclusive 
evidence of the true value of the property and the true 
amount of the loss or damage, regardless of the actual 
value of the property. In 1879 this law spread into Ohio, 
Missouri, and Texas, and is now in force in twenty-one 
states. 2 

The law changes a contract to make good the actual 
loss by fire into a plain bet (with average odds of one 
hundred to one in favor of the assured) that his property 
will not burn within a stated time. With such odds, a 
bet on almost any future event beyond the control of 
either party would find many takers; but when a man 
carries the keys of his own house in his pocket, and the 
event is wholly under his control, it is not surprising that 
legalized wagers of this sort should come to be popularly 
regarded as "a cinch." 

1 By A. F. Dean. Reprinted from pages 103-111 of "The Rationale 
of Fire Rates." 1901. Chicago, J. M. Murphy. 

8 At the present time, the valued-policy law appears upon the statute 
books of the following states: Arkansas, California, Delaware, Florida, 
Georgia, Iowa, Kansas, Kentucky, Minnesota, Mississippi, Missouri, 
Nebraska, New Hampshire, Ohio, Oklahoma, Oregon, South Carolina, 
Texas, Washington, West Virginia, and Wisconsin. 

293 



294 YALE READINGS IN INSURANCE 

That the law has raised the aggregate cost of fire insur- 
ance to the American people; that it is the direct cause 
of an untold amount of arson, perjury, and murder — 
no one familiar with fire statistics can for an instant doubt. 
The dangers of the law to life, property, and morals have 
repeatedly been pointed out by state officials. During 
the past year, on the ground that it offered an incentive 
to crime, the law was vetoed by the governors of Colo- 
rado, Nevada, and Utah, and the governor of West Vir- 
ginia refused his signature. In his last annual report, 
the insurance commissioner of Ohio published statistics 
showing the increase in fire losses in that state since 
the enactment of the law, and ends with the following 
comment: 

"I have no hesitancy in believing that over-insurance, 
sanctioned and encouraged by the valued-policy law, is 
the cause of the greater portion of this increased fire waste, 
and that this unnecessary waste will continue and grow 
worse so long as this statute remains a part of our insur- 
ance code." 

The state insurance commissioner of Michigan, in his 
last annual report, condemns the law in language equally 
strong, and estimates the losses from moral hazard, arising 
from over-insurance in his state, at 25 per cent, of the 
aggregate fire waste; in other words, that incendiarism 
is the cause of one fire out of every four. 

The law enacted in Wisconsin in 1874, and since that 
time by twenty other states, was originally intended to 
right an existing wrong, and the history of valued-policy 
legislation throws an instructive side-light upon the other- 
wise unaccountable antagonism of legislatures to the 
industry of fire insurance in all states dominated by the 
farmers' vote. 

Thirty years ago farm property formed a much larger 
proportion of our aggregate national wealth than it does 
to-day. At that time the tremendous growth of our manu- 
facturing and transportation facilities, and the concen- 



VALUED-POLICY LAWS 295 

tration of population in our cities was just beginning. 
The fire companies were then deriving a steady revenue 
from the insurance of farm property, which as a class was 
considered doubly desirable, because it had been steadily 
profitable, and because it was free from the dangers of 
sweeping conflagrations which in every city jeopardized 
the entire assets of a company. 

Every company wrote farm business freely through its 
local agents, under the same liberal conditions as other 
classes of property. The volume of farm business and 
its exceptional desirability led some managerial genius to 
conceive the idea that he could largely increase the pre- 
miums of his company from this source by sending out 
traveling solicitors through the country districts, after the 
manner of the lightning-rod, chain-pump, and patent- 
churn people. As these solicitors were selected for their 
glibness and push, rather than for their character or knowl- 
edge of the business, and as neither their judgment nor 
honesty could be trusted, the plan was adopted of taking 
payment in notes instead of cash. An elaborate applica- 
tion containing a cut-throat warranty was prepared, under 
which the assured surrendered every equitable right, and be- 
came responsible for any over-valuation of his property; and 
to make assurance doubly sure every policy contained a 
printed stipulation that the company should be liable for 
only three-fourths of any loss that might occur. This 
plan relieved the company of any necessity for the ser- 
vices of local agents, selected for their honesty and skill. 
There was no cash to handle; no danger of defalcations, 
and (with a policy condition which compelled the assured 
to carry one-fourth of the insurance for which he had 
paid) no danger from over-insurance. Under this jug- 
handle arrangement it became possible to sell fire indem- 
nity, like tinware, by pedling. 

The farmer is generally ready to purchase anything he 
can pay for with a note, and as "a business getter" the 
plan was a success. In a few years the agricultural 



296 YALE READINGS IN INSURANCE 

regions swarmed with traveling solicitors ready to sell a 
farmer a patent churn, windmill, stump-puller, or fire 
policy with the same glib disregard of the truth. These 
tramp solicitors were, as a rule, ignorant, unscrupulous 
adventurers. They were paid by a percentage of the pre- 
miums, and it was, of course, to their interest to make 
as large a sale of indemnity to every buyer as possible, 
regardless of his actual needs. The companies themselves 
could afford to be indifferent to the amount of insurance 
a man procured, as misrepresentations in application could 
be used to deny liability, and in any event, the assured 
could not collect more than three-fourths of his actual 
loss. In time, the adjustment of losses revealed the full 
iniquity of this plan, and in every farming community 
fire insurance came to be regarded as a swindle. Of the 
hundreds of fire institutions then doing business, not 
over four or five at most were implicated. Nineteen com- 
panies out of twenty vainly protested at the buccaneering 
methods of these so-called farm companies, believing they 
would bring the entire business into reproach and subject 
it to inimical legislation. These apprehensions were well 
founded. The industry of fire insurance became non grata 
in every state where the farmers had the controlling voice 
in legislation, and the entire insurance community has 
been made to suffer ever since for the sins of a few unprhv 
cipled adventurers. 

The American farmer to-day is the hereditary foeman 
of fire insurance; he makes no distinction between com- 
panies on account of character, record, or methods; in 
the words of a popular song, "All coons look alike" to 
him; the few companies whose solicitors he learned to 
distrust in the palmy days of farm insurance are typical 
of the whole body of fire underwriters. In his ignorance 
of the facts, the readiest remedy that occurred to the agri- 
culturalist was to wipe out the whole iniquity with a sweep- 
ing law which required that the amount of insurance should 
be taken as the real value and measure of loss, regardless 



VALUED-POLICY LAWS 297 

of policy conditions or actual loss. The offer of a reward 
to any one sharp enough to swindle an insurance company 
was a practical application of the maxim, "Set a thief 
to catch a thief"; but in resorting to this crude remedy 
the farmers forgot to consider the possible consequences 
to either their own or other people's interests. 

Probably no more absurd or dangerous means was ever 
devised to right a wrong, and the farmers themselves 
have come in for much the largest share of the evil conse- 
quences of their own hasty and ill-advised action. The 
valued-policy law has cost the farmers millions of dollars, 
to say nothing of other people. In Wisconsin, Ohio, 
Texas, and Missouri, where the law has been longest in 
force, farm rates to-day are about double what they were 
when the law was enacted. At that time, all companies 
were freely writing farm risks through their local agents 
under the same form of policy, and at the same commis- 
sions that prevailed in other business. Ask any agent 
to-day, and he will reply that few or none of his companies 
will insure farm property at any price. The very com- 
panies responsible for the valued-policy law have been 
forced by the unprofitableness of the business, even at 
present high rates, to discontinue writing farm property 
in states where the law exists. These companies killed 
the goose that laid the golden egg, by creating a wide- 
spread moral hazard in a class of property that had been 
notably free from incendiary hazard. With an advance 
of about 100 per cent, in rates in valued-policy states, 
farm property to-day appears on the prohibited list of 
nineteen companies out of twenty, because losses have 
increased even more than rates. 

This is the history of a law born of blind, unreasoning 
greed on the one hand, and blind, unreasoning resentment 
on the other. 

These conditions are the results of open competition. If 
farm business had been under control of tariff associa- 
tions, the united intelligence and honesty of fire under- 



298 YALE READINGS IN INSURANCE 

writers would have scotched the disreputable schemes that 
generated an equally disreputable law. 

In states where the law has not already been enacted 
it is regularly introduced each session of the legislature 
and voted for by the country members. If asked why, 
the invariable answer is, that insurance companies sys- 
tematically encourage people to buy fire indemnity in 
excess of what they need; in other words, that they take 
money for which they render no equivalent. This is the 
stereotyped argument urged in state legislative halls year 
after year. To say nothing of the poverty of invention 
that can devise no remedy for an evil except to create a 
thousandfold greater evil, that can devise no penalty 
for a few minor evil-doers except to create thousands of 
criminals, whose crime has been held under every civili- 
zation to be worthy of the death penalty, what shall we 
say to the legislative inconsistency that imposes a penalty 
for an offense which is common to every walk of life, even 
to the law-making power that enacts valued-policy laws? 

lit 

Since the last report made to the Board, a large number 
of bills adverse to insurance interests have appeared in 
several state legislatures throughout the Union. The 
Board through its proper committee has given attention 
to the same as in former years, and circulars and letters 
have been addressed to companies interested, in states 
where obnoxious legislation has been proposed. We have 
in most cases been effectively aided by the influence of the 
companies and agents local to the respective states, as well 
as by the general, state and special agents of the agency 
companies, acting either individually or through under- 
writers' associations. If not in a majority, certainly in 
a considerable number of instances, the bills have been 
defeated largely by the judicious and timely attention 

1 By D. A. Heald. Reprinted from pages 20-24 of the Presidential 
Address before the National Board of Fire Underwriters, July, 1886. 



VALUED-POLICY LAWS 



299 



of companies and their representatives. The pernicious 
valued-policy law which, since its enactment in Wiscon- 
sin, has reappeared each winter in so many of the state 
legislatures, received in New Hampshire during the 
summer of 1885 a brand of disapproval most emphatic 
and decisive on the part of the companies doing business 
in that state. The bill was to be deprecated not only on 
account of its valued features, but because it provided for 
a revocation of the authority to do business in the state, 
for any company which should enter into any compact 
with other companies, for the purpose of governing or 
controlling rates of fire insurance. Having passed both 
branches of the legislature, the bill became a law to take 
effect January 1, 1886, by the signature of the governor 
on August 29, 1885, and, in accordance with a mutual 
understanding, all of the companies — fifty-eight in num- 
ber — of other states, and all of the companies chartered 
by foreign governments withdrew from the state. 

Attention is here invited to the following table given 
by Superintendent Reinmund of the Ohio Insurance 
Department, in his report for 1885, published in 1886, 
in which he recommends a repeal of the valued-policy, 
or so-called "Howland Law," in that state, which has 
been in force since July 1, 1880. 

"The fire insurance business of the joint-stock com- 
panies, in Ohio, for the past ten years shows the following 
results: 



Year 


Risks Written 


Premiums 


Losses 


Ratio of Loss 
to Each $100 
of Premiums 


1876 . . 

1877 . 

1878 . . . 
1879 
1880 


$290,415,146 
293,020,072 
297,243,412 
269,334,609 
296,154,409 


$3,676,516 
3,231,629 
3,337,812 
2,772,868 
3,127,331 


$1,549,904 
1,337,461 
1,399,904 
1,295,477 
1,395,494 


42.20 
41.40 
41.90 
46.70 
44.60 


Totals 


$1,446,167,648 


$16,146,156 


$6,978,240 


43.20 



300 



YALE READINGS IN INSURANCE 



Howland Law, July 1. 



Year 


Risks Written 


Premiums 


Losses 


Ratio of Loss 
to Each $100 
of Premiums 


1881 

1882 

1883 

1884 

1885 


$331,701,721 
369,872,828 
402,796,360 
495,554,856 
398,988,338 


$3,588,931 
4,058,627 
4,490,010 
4,676,370 
4,704,732 


$2,068,889 
2,356,851 
2,355,677 
3,507,848 
2,714,455 


57.60 
58.10 
52.50 
75.00 
58.80 


Totals 


$1,908,914,103 


$21,518,670 


$13,003,720 


60.40 



"From the above it will be seen, that the average ratio 
of losses to premiums in Ohio for the five years since the 
passage of the ' Howland Law' has increased 17 per cent." 

Ratio of loss to each $100 of risk written 1876 to 1880. .48 
Ratio of loss to each $100 of risk written 1881 to 1885. .68 

Thus the destruction of property by fire in that state 
has increased from 48 cents on every $100 written to 68 
cents, an increase of 20 cents for Ohio, while the increase 
for the same period throughout the whole country has 
been from 54.14 to 58.36 or only 4 T 2 o 2 ^ cents. Ohio 
has therefore a net increase of 15 T Vk cents on each 
$100 written, in her losses as compared with the entire 
country. Here is a loss to the commonwealth of the 
state of over $3,000,000 in five years as compared with 
the rest of the country, and of nearly $4,000,000, as com- 
pared with the previous five years in her own state. Whence 
this increase? We must look to some disturbing cause at 
work in Ohio, which has not existed in other states. We 
need not go far for the cause. The silent influence of the 
law, overturning the fundamental idea of fire insurance 
based upon actual indemnity to the insured, and sub- 
stituting therefor a fixed and arbitrary value to the thing 
destroyed irrespective of its real value, is amply sufficient 
to account for this alarming increase. To the honest 
insurer this law offers no sufficient inducement for perjury 



VALUED-POLICY LAWS 



301 



and arson, but to the dishonest it is too often a command- 
ing incentive to crime, and in these figures is the absolute, 
irrefutable proof of its terrible influence. These three to 
four millions is the price paid to the dishonest minority 
of Ohio by the vast majority of her good and true citizens, 
for a law far more fatal to her morals than it is or ever 
can be to her material wealth. How long will the states- 
men of Ohio permit this law to disgrace her statute book, 
demoralize her citizens and waste her wealth, as it is here 
proved clearly and conclusively to have done, by facts 
beyond dispute. 

Wisconsin is the only other state in which a similar 
law has been in force for a length of time, sufficient for 
reliable deductions. The increase of the loss ratio in that 
state is also remarkable. The figures from the official 
reports of the Wisconsin Insurance Department for eight 
years previous to the decision of the Supreme Court of 
the state, holding the law constitutional, and the eight 
years succeeding when it may be said to have been in 
full force and influence, will show the following results: 



Losses for Eight Years Prior to the Enactment of the Law. 



Year 


Amount Written 


Premiums 


Losses 


Ratio of Loss 

to Each $100 

of Premium 


1870 


$147,172,955 


$1,622,332 


$1,175,212 


72.44 


1871 


122,084,464 


1,436,197 


713,080 


49.65 


1872 


142,351,376 


1,910,677 


922,637 


48.29 


1873 


157,406,089 


2,174,931 


993,281 


45.67 


1874 


154,795,630 


2,271,059 


1,010,023 


44.00 


1875 


147,440,317 


2,110,034 


1,877,111 


*89.00 


1876.... 


133,614,294 


1,798,428 


634,674 


34.00 


1877 


146,983,804 


1,645,110 


973,913 


59.00 


Totals 


$1,151,848,929 


$14,968,768 


$8,299,931 


55.44 



* Loss by Oshkosh fire included; the amount of same paid by com- 
panies being stated by the Wisconsin Insurance Superintendent at 
$920,438. 



302 



YALE READINGS IN INSURANCE 



Losses Since the Law Went Into Force. 



Year 


Amount Written 


Premiums 


Losses 


Ratio of Loss 

to Each $100 

of Premium 


1878 


$140,411,389 


$1,508^955 


$965,478 


64.00 


1879 


151,731,034 


1,589,472 


1,037,193 


64.00 


1880 


159,110,857 


1,766,528 


1,143,541 


61.50 


1881....'. 


161,574,070 


1,997,317 


957,816 


47.92 


1882 


175,210,508 


2,238,463 


1,340,372 


59.00 


1883 


188,113,382 


2,525,690 


1,748,180 


69.00 


1884 


199,205,324 


2,683,737 


2,010,901 


74.90 


1885 .... 


196,101,759 


2,838,815 


2,222,631 


78.30 


Totals 


$1,377,458,323 


$17,148,977 


$11,426,112 


66.62 



Ratio of losses to each $100 of risks written, for 
eight years, 1870 to 1877 72 

Ratio of losses to each $100 of risks written for 
eight years, 1878 to 1885 83 

Here nearly the same results are repeated as in Ohio. 
The first period of eight years shows a ratio of loss to 
premiums of 55.44, the second 66.62, an increase of 11.18 
— with this alarming feature that the two last years after 
adding the ratio of expenses gave results for 1884 — losses 
69 per cent., expenses 33.38, total 102.88, or a net loss on 
the business of the entire state to all the companies, of 
2iVo P^ cen t- of premiums. In 1885, losses 74.90, ex- 
penses 35.82, total 110.72, a net loss of lOyVV How long 
can responsible underwriting stand up under such con- 
ditions? 

If we come to that which more nearly concerns the people 
of the state, we find that the ratio of loss to $100 insured, 
has increased from 72 cents in the first period to 83 cents 
in the second — a difference of 11 cents on every $100 in- 
sured in the state during that time. Here, too, is shown 
a cause at work that has produced greater loss by 6i 7 ^ 
cents on each $100 than that of the whole country. The 
conclusion is inevitable that 6yW cents on each $100 
insured is the contribution made by the honest policy- 



VALUED-POLICY LAWS 303 

holder of Wisconsin to the grasping cupidity of such as 
have taken advantage of a bad law at the expense of con- 
science and integrity. These tables are here placed on 
record without further comment, as a verification of the 
prediction of intelligent underwriters as to the effect of 
valued-policy laws, and the results exhibited should cer- 
tainly lead to their unconditional repeal by all the states 
where they now exist. 

A fair presentation of the self-evident arguments against 
such laws, and a clear statement of the evils wrought by 
them, as shown by the sworn reports of underwriters doing 
business in such states, will, we venture to say, lead to 
their repeal. Business cannot be transacted safely under 
such laws. The honor, integrity, and moral welfare of the 
state demand their repeal, and a candid and truthful 
statement of facts and figures on our part will, in my 
judgment, secure this most desirable object at an early 
day. 

IIIi 

The valued-policy feature of the law is alleged by the 
companies as their principal grievance, under which, they 
declare, they cannot safely and profitably do business. 
Of their inability to do business successfully for themselves 
on that basis, I am not persuaded. To adapt their busi- 
ness to the new situation created by the law might, and 
probably would, occasion inconvenience, expense, and 
change of habit, but it could be done. I am, however, 
well convinced they ought not be compelled to, and for 
solid reasons, apart from their interest or inclination, they 
should not be permitted to. Nor would the public be con- 
tent with it. Under the open policy, the property owner 
may obtain full protection against loss. Under the valued 
policy, no company could prudently write insurance to the 
full value of the insured property. A margin would need be 

1 Reprinted from pages XXXVII-XLI of the Thirty-First Mass- 
achusetts Fire and Marine Insurance Report. 



304 YALE READINGS IN INSURANCE 

left, liberal enough to cover surely any excess in original 
valuation, and also the possible deterioration in value 
within the insurance term. While in administration, the 
valued plan might tend, in some degree, to abate the con- 
ceded mischief of over-insurance (for which another and 
better remedy should be found), it would, as surely, create 
a popular complaint of under-insurance. A judgment 
entitled to respect, if not conclusive, has already been 
pronounced upon the relative merits of the two plans. 
With free and equal chance of competition for public favor 
and business approval, the valued fire policy has yielded 
place to the open indemnity form everywhere. 

The question is to be considered in its relation to sound 
public policy, and a recurrence to the essential nature of 
the insurance contract should be helpful to a just opinion. 

An eminent authority correctly defines insurance as "A 
contract whereby one, for a consideration, undertakes to 
compensate another if he shall suffer loss. ... It is appli- 
cable to every form of loss. . . . Wherever danger is appre- 
hended, or protection is required, it holds out its fostering 
hand and promises indemnity. This principle (indemnity) 
underlies the contract, and it can never, without violence 
to its essence and spirit, be made bjr the assured a source 
of profit, its sole purpose being to guarantee against loss 
or damage." 

Legitimate insurance cannot overpass the limit of com- 
pensation for actual loss. A contract which promises more 
than that is, as to the excess, a naked wager, condemned 
by law and hateful to good morals, and, applied to insurance 
of property liable to destruction by the machination of the 
assured who would profit by it, offensive to public policy 
because a temptation to social crime. A valued policy 
which over-insures is such a contract, and the statute 
under discussion protects it. 

This principle of insurance, as indemnity, is recognized 
and enforced in the Massachusetts standard form of fire 
insurance policy, which all companies are required by law 



VALUED-POLICY LAWS 305 

to write, in those clauses of the policy which limit the lia- 
bility of the company to the actual value of the property 
and provide that the amount recoverable "shall be esti- 
mated according to the actual value of the property at the 
time when the loss or damage happens." 

But, the advocate may argue, the valued policy is a con- 
tract of indemnity only. It simply fixes the amount by 
agreement in advance. What amount is indemnity is a mat- 
ter of estimate, and why may not the estimate be made by 
appraisal and agreement before, as well as by adjustment 
after the loss? The answer to the argument is not diffi- 
cult. The true indemnity is the injury by the loss, and 
that is measurable only by the value of the lost property 
when the loss occurs. Between the contract and the loss, 
the value of the property may sensibly diminish, whereby 
the moral hazard is made greater, and if insured for full 
value at date of contract, under a valued policy the assured 
gets profit in addition to indemnity. To estimate value 
at date of the policy, or at date of loss, is feasible, because 
the valuation can be made from known facts; but a 
reliable valuation of what property will be worth at an 
uncertain future date is not possible. If the company is 
to be bound conclusively by the policy valuation, however 
clear the error, it must, before issue of the policy, cause a 
careful and competent valuation of each parcel of property 
it insures; and, furthermore, it must establish a system of 
supervision of all its risks of that class, in order to protect 
itself by cancelation of policies should the property de- 
preciate. The burden of cost incident to these prudential 
measures, and chargeable to the valued policy, would fall 
upon the public. 

Companies are obliged to act largely in the negotiation 
of insurance through agents other than their immediate 
officers. And in the selection of such agents the company is 
not always able to obtain the services of wholly trustworthy 
persons. Yet to these persons would be confided the val- 
uation of the insured property and the amount of insurance 



306 YALE READINGS IN INSURANCE 

based on that valuation. For the protection of the people 
it is fit and of legal obligation that the company should be 
held liable and bound by certain acts of these agents in 
their insurance transactions, yet that liability should be 
imposed no farther than the necessities and equity of the 
case. But under the valued-policy law the company is 
bound by the agent's valuation, however false or treach- 
erous, and unless corrupt collusion with the assured can 
be proven. True, the statute permits the policy may be 
voided by proof of fraud in which the assured participates. 
But such actual fraud is usually extremely difficult and 
often impossible of proof and this law tempts to its com- 
mission. Where the over-valuation is the fault of the 
agent, from his incapacity, neglect, or corrupt yielding 
to the temptation of a larger reward from the transaction, 
the law refuses a remedy and enforces the injustice. Surely 
that cannot be good legislation which incites to wrong 
and shelters it, and impairs the customary freedom of 
private commerce, unless justified by the prevention of 
some graver injustice not curable by less objectionable 
means. 

The valued clause is defended on the ground that as a 
matter of equity the company should be liable for the sum 
of insurance it is paid a premium upon. There can be, 
however, no lawful equity between gamesters. Com- 
panies may be willing to gamble with the owner or other 
person upon the chances that a piece of property will or 
will not burn, — and that is essentially what a policy of 
insurance becomes when it ceases to be a contract of in- 
demnity. But the state should not lend its authority to 
enforce a contract repugnant to public morals, however 
willingly entered into by the equally culpable parties to 
it. Our courts hold that a contract of insurance made 
with a person who has no interest in the property is a 
wager and void in law. Why, for like reason, should not 
a contract which insures for an amount more than the 
insurable interest be equally condemned as a wager and 



VALUED-POLICY LAWS 307 

illegal? If a man insures his property for more than it 
is worth, he does so, not to protect himself from a possible 
injury, but for the gambling chance of a possible profit. 
If, under those circumstances, the law assures that he 
shall realize the profit if the property burns, does not the 
law tempt him to destroy it? A contract for a considera- 
tion to pay the assured the amount of damage he may 
suffer is legitimate insurance, whence arise rights the law 
will protect. But a contract to pay more than the damage, 
violates the wholesome law of both private and social 
morality, and the parties who make it acquire no rights 
which the civil law should respect or honest men sym- 
pathize with. There are insurance companies willing to 
gamble with this sort; and with the valued policy protect- 
ing such transactions with its legal shield, legitimate in- 
surance would suffer from the unworthy competition. 

The other reason urged in the support of the justice 
and expediency of the law, is that the companies un- 
fairly and vexatiously dispute the settlement of losses 
when the amount payable is subject to adjustment. 
This assumption of fact is not verified, and the argument 
sought to be built upon it must fall for want of foundation. 
My observation is that the companies, conscious of their 
disadvantage in litigation and sensitive to the popular 
prejudice, injurious to their patronage, which such contro- 
versies are likely to excite, submit to claims they might 
in good faith, and ought, in justice to themselves and the 
public, to resist. From self-interest, if no worthier im- 
pulse, as a rule with extremely rare exceptions, they lib- 
erally perform their obligations. No reason is given, or 
suggests itself, why a party dissatisfied with the proposed 
adjustment of his loss under an insurance contract, should 
not be remitted for a redress of his grievance, if he has a 
real one, to the established tribunals of justice. What is 
there singular in the nature of the contract, or the rights 
and obligations incident to it, that should distinguish it, 
as respects the legal rights and remedies of parties to it, 



308 YALE READINGS IN INSURANCE 

from other contracts which men make in ordinary business 
intercourse? This law applies solely to insurance upon 
buildings and real estate, and to cases of total loss. In a 
dispute as to value in such a case the assured has an equal, 
if not superior, advantage in the contention, from the 
friendliness of the tribunal he may resort to, and his 
knowledge and ability to prove value. If he wants but 
justice he is sure of that, and often gets more, in the courts. 
While recognizing the function of government to protect 
the weak from the oppression of the strong, I perceive no 
circumstance in the case under discussion for the extraor- 
dinary intervention of that power. 

The conclusions to which these considerations lead are: 
(1) that the valued-policy law violates the essential prin- 
ciple of the insurance contract, a principle it is most pru- 
dent to cleave to; (2) that it protects no endangered rights 
since the protection of the courts is ample for the purposes 
of justice; (3) that its tendency is to promote dishonesty 
and crime, the burden of which the public must endure. 



CHAPTER XVI 

FIRE INSURANCE FINANCE 1 

A fire office receives its premium income from a 
vast number of sources and most of these sources are 
themselves small. On the other hand, its principal 
outgoings are in comparatively large sums for fire 
claims, and if a profit is to be made it is at least as 
important to limit as far as possible the amounts pay- 
able in claims as it is to keep up the rates of premiums. 
Excessive claims are avoided by carefully limiting the 
" lines" of individual companies on risks — the bigger 
the risk the smaller the line — and by distributing 
the liabilities of a company over the widest possible 
area. The maximum lines held by companies on 
single risks vary according to the size of the companies. 
A strong office will hold, say, £10,000 on a large pri- 
vate house in a town and £3,000 on a cotton or woolen 
mill. The limitation of lines on buildings and " blocks " 
of buildings, and the provision for reinsurance facili- 
ties with other companies, so that an excessive line is 
not run for a single night, and the sifting out of un- 
profitable risks before they can do much harm, are 
a severe test of competence in insurance management. 
There are some companies who go on year after year 
making profits while other companies fluctuate very 
much, making large profits one year and perhaps losing 

1 From pages 212-223, 237-241, 244-245, 247 of F. Harcourt Kitchin's 
"Principles and Finance of Fire Insurance," 1904, London, Effingham 
Wilson. 

309 



310 YALE READINGS IN INSURANCE 

money in the next. The managers of the first class of 
companies show by the severe test of actual results 
that their system of limiting lines and reinsuring or 
refusing excessive hazards is a sound one, and those 
managers who show widely varying results according 
as a fire insurance year is "good" or "bad" are clearly 
to a much greater extent than the former class depend- 
ent on luck. Strictly speaking there should be no 
such thing as luck in fire insurance, either good or bad. 
The function of a competent manager is to eliminate 
luck from his operations, and the fact that few men 
succeed in really eliminating it simply shows that the 
first-class fire insurance manager is a very rare thing. 
In a good fire insurance year almost any one can make 
money, but in a bad year profits are very difficult to 
make, and it is bad years which form the test of the 
highest competence. Success does not depend upon 
the piling up of premiums — that is comparatively 
easy — it consists in limiting and avoiding losses. 
That is the first point to bear in mind. We are living 
in an age in which merit is erroneously attached to 
mere size. The hunger for size is a disease, and many 
of the amalgamations which we have seen — some of 
them on terms which must strike an observer as pre- 
posterous — are merely symptoms of disease and not 
of competent management. The theory which lies 
at the root of the desire for size is almost always 
fallacious. It is urged that a big company can conduct 
its operations at less relative cost than a small one, 
but how often do we see a big company really showing 
a lower rate of expenses than a small one? As a 
matter of fact, the expenses of conducting fire insur- 
ance, in spite of the alleged benefits of expansion and 
of amalgamations, show a constant tendency to rise, 
and an examination of fire insurance accounts over 
a considerable period indicates that the advance in 
expenses is very large indeed. Since next to the item 



FIRE INSURANCE FINANCE 311 

of fire claims the most important outgo consists of 
expenses and commission, the item of expenses needs 
as careful watching and curtailing as does that of 
claims. Let me give an example of this. 

For the ten years to 1895 the total expenses and 
commission of British fire insurance companies aver- 
aged 31.6 per cent, of the premiums. Now take a 
jump to the last two years 1901 and 1902. In those 
years the proportion of expenses and commission to 
premiums was 34.03 per cent, and 34.46 per cent, 
respectively, showing an advance in expenses and 
commission in the latter year as compared with 1886- 
1895 of nearly 3 per cent, of the premiums. When 
we reflect upon the small margin of profit permitted 
to fire insurance operations over a period of years, 
we see what a great effect may be caused by an ad- 
vance in expenses. For example, the net profit for 
the ten years to 1895, after allowing for the increase 
in liabilities, was only 6.5 per cent, of the premiums, 
and if the expenses during those ten years had been 
at the same rate as for 1902 the net profit would have 
been reduced to 3.6 per cent, of the premiums, a profit 
which can hardly be described as sufficient when the 
enormous risks of the business are taken into account. 
Indeed the risks are so great and the margin of profit 
so small that it is rather a remarkable thing that fire 
insurance is capable of being conducted so as to pro- 
duce a trading profit at all. That it does so at all is 
due to the fact that insurance companies like banks 
are trading not on their own capital but on other 
people's money. The profit is earned on the whole 
turnover, not on the comparatively small paid-up 
capital, and a very minute percentage of profit on the 
large turnover is, together with the interest on the 
funds accumulated during past generations, able to 
produce a sufficient amount to yield high nominal 
dividends on the small capital. But it cannot be too 



312 YALE READINGS IN INSURANCE 

clearly understood that it is the interest on the funds 
rather than actual fire insurance earnings which in 
most cases enables these dividends to be paid. 

The margin of actual profit is so small that in a 
bad year — a year which produces an amount of fire 
claims above the average — it has a way of disappear- 
ing altogether. And this risk of the disappearance 
of profits is greater now that the proportion of expenses 
and commission to premiums has advanced. In 1901, 
which was a most unfavorable year in the United 
States and Canada, where the British offices conduct 
large operations, the fire claims amounted to 63.69 
per cent, of the premiums. The expenses and com- 
missions were 34.03 per cent, and the nominal gross 
surplus of claims and expenses over premiums was 
2.28 per cent., an amount which is poor enough as it 
stands. But as a matter of fact not even this beggarly 
sum was profit since the increase in liabilities must be 
allowed for before we can call any surplus a profit. 
I reckon this increase in the liabilities at the end of 
1901 at 3.1 per cent, of the premiums, a result which 
brings out a net loss on the year of .82 per cent, of the 
premiums, or about £160,000. As the receipts from 
interest were not in 1901 sufficient to provide the 
customary dividends — some reductions were made 
but not many — the balance had to be made up out 
of the reserves. That is to say, the proper provision 
for increased liabilities was not in all cases made, and 
the money which according to strict finance ought to 
have gone to meet this increase in liabilities was paid 
in dividends. 

Now that would be an example of very bad finance 
if it were not quite an exception and due to the un- 
usual fire losses of the year. It would be manifestly 
wrong to go on for years paying dividends at the 
expense of reserves, and this is a practice which has 
in the past brought insurance companies to something 



FIRE INSURANCE FINANCE 313 

approaching ruin. But to maintain dividends in, say, 
one exceptional year by a draft on reserves is not 
necessarily bad finance if the condition is really ex- 
ceptional and one not affecting to any serious extent 
the position of a company. But, generally speaking, 
dividends should be quite a secondary consideration 
and the maintenance of reserves one of primary 
importance. 

I have given an example from a bad fire year and 
will now give one from a good year, namely, 1902. 
In that year the fire claims were 52.2 per cent, of the 
premiums as compared with 63.69 per cent, in 1901 
and the expenses and commission amounted to 34.46 
per cent. There was thus a gross surplus of premiums 
over claims and expenses of 13.34 per cent, as against 
2.28 per cent, in 1901. The amount of this gross 
surplus was £2,918,000. The interest receipts were 
£1,344,000. The total amount paid in dividends was 
£1,950,000, of which you will observe £1,344,000 
was provided out of interest on the funds and only 
£606,000 came out of the gross surplus of £2,918,000. 
From this surplus as much as £1,860,000 was 
added to the permanent fire funds, an addition 
which was far in excess of the amount required to meet 
the increased liabilities. This year, 1902, was a good 
year and the profits, instead of being frittered away 
in paying increased dividends, were very properly to 
a large extent carried to reserve, thus more than mak- 
ing up for the losses of 1901 and leaving the companies 
as a whole much stronger than they were in 1900. 
That was good finance, namely, taking advantage of 
exceptional profits in order to strengthen resources 
instead of paying them away in dividends. 

When one comes to think of it, the gross surplus 
each year, when there is one, of premiums over ex- 
penses and claims has to carry the whole burden of 
financing fire insurance companies. It is the one 



I 



314 YALE READINGS IN INSURANCE 

source which provides assets to meet an increase in 
liabilities, which provides permanent reserves and 
which makes up deficiencies in the dividend fund after 
receipts from interest have been taken credit for. 
These same receipts from interest which form the 
principal source of the shareholder's dividends are due 
to the accumulation of reserves in the past invested 
in interest-bearing securities. The surplus of pre- 
miums over claims and expenses, which taking one 
year with another is less than 8 per cent, of the pre- 
miums, has to provide for two kinds of reserves, those 
for the increase in current liabilities and in the per- 
manent fire funds, and also a credit balance for profit 
and loss — that is for shareholders' dividends. There 
is probably no business of the magnitude of fire in- 
surance, certainly no business which is so difficult 
and risky, which is conducted on such a small margin 
between a surplus or deficit on the operations. 

I should like my readers to consider the reserves of 
fire insurance companies before we pass on to examine 
their finances more closely. The fire reserves are, 
together with the capital (paid and uncalled), abso- 
lutely the backbone of the business. They form the 
security on which the public rely when they pay their 
premiums. Upon these reserves depends the ability 
of a company to meet its claims, and without adequate 
reserves fire insurance is little more than a gamble. 
Most of the fire insurance companies have adequate 
reserves though, as I shall show, they have relatively 
to the business been declining during the past eighteen 
years or so, and in some cases where a company's 
reserves have become perilously scanty, recourse has 
been had to amalgamation with a more powerful 
office. Amalgamation in a case of this kind is vastly 
preferable to bankruptcy, which is a much worse and 
more momentous event in the case of an insurance 
company than of an ordinary trading concern. I 



FIRE INSURANCE FINANCE 315 

know at present of only one instance in which a fire 
insurance company — it is not English or Scottish — 
is trading without fire funds at all and which has 
no provision even for current liabilities. The sole 
security in this instance is the uncalled capital. This 
company forms a striking exception to the general 
rule of insurance security. The financial position of 
nearly all the well-known British companies is un- 
questionably sound, though in some instances their 
financial methods are open to criticism. But taking 
fire insurance companies as a class they will compare 
very favorably indeed with banks or any other finan- 
cial institutions. 

The reserves of a fire office which, as I say, are built 
up out of the annual surpluses of premiums over 
claims and expenses, have a great deal of work to do. 
In the first place they provide for the liabilities on 
current policies, for the unexpired risk that is on the 
ordinary business. I shall go into this subject later 
in some detail. For the moment it is enough to say 
that at the end of any year from one-third to about 
45 per cent, of the premium income is unearned and 
has to be set aside. The premiums have been received 
in advance, but the risks to which they relate have not 
expired. 1 After providing for the liabilities on current 
risks the reserves have to provide for exceptional 
losses beyond the ordinary expectation. The great 
hold which British offices have secured in the United 
States is largely due to the manner in which they 
provided almost at a day's notice for the immense 
exceptional losses in the Chicago and Boston fires. 
Without large reserves such losses could not have been 

1 In the United States, the term "reserve" is often popularly, but 
loosely, identified with "unearned premium," few American com- 
panies setting aside reserves for any definitely assigned objects except 
to meet the minimum statutory requirements with respect to reserve 
on account of unearned premium. W. H. P. 



316 YALE READINGS IN INSURANCE 

met. In the same way the British companies could 
not have met their losses of some £1,800,000 in the 
recent Baltimore fire without loss of credit had not 
the reserves been ample. Then the reserves have to 
provide for a dividend equalization fund and supply 
the deficiencies in earnings in bad years so that, as 
far as possible, dividends may be maintained. It 
adds to the good repute of a company in financial 
circles if the dividends are maintained steadily and do 
not jump up and down. Then, lastly, the invested 
reserves are the source from which come the interest 
receipts by means of which so large a part of the divi- 
dends is annually paid. We must therefore regard 
the reserves of a fire office as fulfilling four distinct 
functions: (1) a reserve for current liabilities; (2) 
a permanent reserve for exceptional losses; (3) a 
dividend equalization fund, and (4) the source, when 
invested, from which the interest is derived which 
goes a long way towards meeting the dividends. This 
fourth function is also fulfilled by the paid-up invested 
capital and this capital also adds to the general security 
of a fire office. But as it is usually small in amount 
as compared with the fire reserves, these reserves have 
to provide the greater part of insurance security. 

The different functions which have to be fulfilled 
by a fire insurance company's reserves make it not 
only desirable but highly important that they should 
be divided up and not simply thrown into the accounts 
in one sum. The full division would be into three 
parts: (1) reserve for unexpired risks; (2) permanent 
reserve fund and (3) dividend reserve or shareholders 
reserve fund. 

This third fund is not absolutely necessary as the 
free balance of profit and loss account may fill its 
place, but a distinct provision of the kind tends to 
greater financial clearness. The division of reserves 
into two parts, namely, provision for unexpired risks 



FIRE INSURANCE FINANCE 317 

and for a permanent reserve fund, is essential if sound 
financial principles are to be followed. Yet it is to 
be regretted that in many important cases this divi- 
sion is not made. Rather more than half the fire 
insurance companies, and some of the biggest of 
them, simply lump all their reserves together and 
do not specify that part which is set aside for unex- 
pired risks. 1 I have before me many examples in 
which such a course has led to the serious depletion 
of reserves. 

My readers will see that if a certain proportion of 
the premium income — say, for the moment, 40 per 
cent. — is set aside as a definite provision for unex- 
pired risks, then this special reserve must be main- 
tained each year or public attention will be called to 
the fact that it has not been maintained. If the 
premium income increases then this reserve must be 
increased with it and provision made for the increase 
out of any trading surplus before any sums can be 
carried to profit and loss and become available for 
dividends. If a definite reserve for unexpired risks is 
not set up the temptation in a bad year to starve the 
reserves and carry the whole nominal surplus to profit 
and loss is very great and has not always been resisted. 
In 1901, a very bad year, many companies of high class 
did this, and however much such a course may be 
justified on the ground of expediency, it is certainly 
bad finance. 

A really strong and well-managed company will 
always provide for any increase in its liabilities in bad 
years as well as in good, and will also whenever pos- 
sible add substantial sums to its permanent reserves. 
If both these processes are carried on simultane- 

1 This statement, of course, refers to British, and not to American, 
companies. Since 1909, however, British companies have been re- 
quired by law to report separately their reserves for unexpired risks. 

W. H. P. 



318 YALE READINGS IN INSURANCE 

ously we shall find a much larger increase in reserves 
than if the additions are made spasmodically and 
omitted when the surplus falls below a substantial 
figure. 

Now let us consider how the reserve for unexpired 
risks is determined and how it may be roughly checked 
by those who desire to examine fire insurance accounts 
with intelligence. The bulk of the home business is 
renewed annually and it is usual to regard half the 
premiums at the end of a year as unearned. That 
is to say there is on an average half a year's risk un- 
expired. But it is not necessary for a company to 
hold half a year's premiums against the unexpired risk, 
since if it allowed the current risks to run off or rein- 
sured them with another office it would be free from 
the ordinary expenses of management and commission. 
The expenses and commission have already been 
debited in the year's accounts. We may, therefore, 
deduct from 50 per cent, of the premiums, expenses 
and commission at the rate, say, of 33 per cent., and 
that gives us 50 less 16.5, or 33.5 per cent, (say one- 
third). This is the proportion of premiums usually 
considered sufficient on home annual business as a 
reserve for unexpired risks, though some home offices 
reserve a larger amount. If we look into the matter 
more closely we shall see that such a calculation is very 
rough. The English December renewals amount, I 
believe, to about one-third of the whole year's business 
instead of one-quarter, and the rest of the business 
is divided fairly evenly over the other three quarter- 
days. It is hardly necessary to go into the Scotch 
quarter-days, for which the distribution is different, 
since we only want an approximate estimate of the 
amount of the unexpired risk. If we take the Decem- 
ber renewals at one-third of the year's business we 
shall get something like this: 



FIRE INSURANCE FINANCE 319 

Percentage 

of Business 

Premiums due on 25th December 33.3 

Premiums due on 29th September 22.2 

Premiums due on 24th June 22.2 

Premiums due on 25th March 22.2 

100.0 



That will give us on 31st December practically the 
whole of the December premiums as unearned, three- 
fourths of September premiums, one-half of June 
premiums and one-fourth of March premiums. 

Unearned Premiums 

Per Cent. 

Due 25th December 33.3 

Due 29th September 16.7 

Due 24th June 11.1 

Due 25th March JU5 

66^6 

Deducting one-third of this amount for expenses 
and commission we get the reserve for unexpired 
risks on home annual business at 44.4 per cent, of 
the premiums. It would not be fair to take this 
proportion as the correct necessary reserve as the 
premiums include a good deal of short-period business 
for six months and less which would have run off to a 
greater extent than the annual business. The long- 
term home business is practically negligible as it is 
small in amount. A more elaborate estimate than 
the one I have given was prepared a year or two ago 
by Mr. D. Deuchar, general manager of the Caledo- 
nian Insurance Company, and after allowing for short- 
period risks he brought out the reserve for unexpired 
risks on home business at some 37 per cent, of the 
premium income. The 40 per cent, adopted by some 
strong offices with purely home business would there- 
fore appear to be ample. 



320 YALE READINGS IN INSURANCE 

But when we turn to the United States, where 
there is much long-term insurance, running in some 
cases for as much as five years, we see that the ordi- 
nary reserve of 40 per cent, for unexpired risks is 
insufficient. It is also misleading in the case of Ameri- 
can business to take any approximate proportion of 
premiums as unearned and apply it indiscriminately 
to all companies. Fortunately we have fairly suffi- 
cient data which enable us to know what the reserve 
for unexpired risks in the United States roughly 
amounts to in the case of all the British companies 
which do business there. In their returns to the 
Insurance Department of the State of New York the 
companies are required to state the amount of their 
premiums under one, two, three, four and five year 
contracts and to reserve definite proportions of these 
premiums for unexpired risks. Thus on one-year 
contracts they would be required to reserve one-half, 
and on longer contracts pro rata from the date when 
they were taken out, reckoning all policies from the 
middle of the first year. For example, the reserve 
at the end of 1902 on a four-year policy taken out 
in 1900 would be three-eighths of the premium = 

li years unexpired T - ., ~ ,. ., 

If it was a five-year policy the 

4 years 

reserve for unexpired risks would be one-half, that is, 

2i years unexpired T , , , , 

— — In reckoning the unexpired 

5 years 

period the premiums are taken as having been paid 

on an average in the middle of each year. On the 

same system the reserve on a five-year policy taken 

out in 1902 must be at the end of the year nine-tenths 

- ,, . 4i years unexpired . ,, 

of the premium = — Seeing that 

5 years 

the reserve for unexpired risks required by the insur- 
ance laws of the New York State ranges from one-half 
up to nine-tenths or 90 per cent, of the premiums on 



FIRE INSURANCE FINANCE 321 

five-year policies the total proportion which this 
reserve bears to the premium income must depend on 
the amount of long-term business held by individual 
companies. That is seen to be the case, and in 1902, 
for which year I have the figures before me, the reserve 
for unexpired risks under the United States business 
of British companies in some cases approached 85 
per cent, of the premiums and rarely fell below 70 per 
cent. It will also be seen that a company by dimin- 
ishing its amount of long-term policies may actually 
have a growing premium income with a diminishing 
reserve for unexpired risks. In fact a reserve for 
unexpired risks which on the New York system 
shows a declining proportion to the premium income 
is a certain sign that the long-term risks are being 
run off. 

My readers may have noticed that the reserve for 
unearned premiums required by the New York State 
is larger than the amount necessary to reinsure the 
outstanding risks, and when we are ascertaining what 
the liabilities of fire offices really are we ought to 
deduct from the nominal reserves for unexpired risks 
about 35 per cent, for commission and expenses. 

An examination of the published accounts of the 
British fire insurance companies for the past fifteen 
years shows that in very many cases a considerable 
decline in reserves has taken place. The actual 
amount has increased largely, but the proportion of 
resources to premium income — in other words to 
liabilities — has fallen off. This shows that the busi- 
ness of the insurance companies has increased much 
faster than financial provision for it. In some cases 
the decline has been very great and serious and has 
precipitated amalgamation with other companies. 
In a few other cases the reserves have fallen to a point 
which suggests dangers in the future. The decline 
in reserves makes it of pressing importance that at 



322 YALE READINGS IN INSURANCE 

the very least an adequate provision for unexpired 
liabilities should be set aside every year, for unless 
this is done the reserves may sink — and have some- 
times sunk — to a point where they are insufficient 
to ""meet current liabilities and no provision is left for 
exceptional losses. 

The importance of very full reserves in the case of 
fire insurance companies will be generally admitted, 
and where they are not maintained at an adequate 
level disaster must inevitably come sooner or later. 
Their provision requires the most constant watch- 
fulness on the part of directors and managers and 
self-denial on the part of shareholders. To pay divi- 
dends at the expense of reserves is the costliest kind 
of folly, and the history of fire insurance is full of the 
wrecks caused by the subordination of security to 
dividends. 



CHAPTER XVII 

EXPENSE PROBLEMS l 

Out of every dollar that is paid into a fire insurance 
company on the average 38| cents is paid out for 
expense. This seems a very large amount for a busi- 
ness which consists, essentially, simply in the collection 
and subsequent distribution of money. The following 
may be taken to be a normal distribution of this: 

Per cent 

Salaries, rent and general administrative expense .... 7.5 

Commissions 21.5 

Taxes 2.5 

Special agents — salaries and expenses ....... 3.5 

Inspections, local boards, etc 1.5 

Printing, postage, etc 2.0 

3&5 

The largest single item of expense is the 21.5 per 
cent, that is paid to agents for commissions. This is 
a large amount to pay to a middleman. It is necessary 
to see just what value is received for this, just what 
the service is which is performed by agents. 

The agent in fire insurance is far more important 
than is generally recognized. He it is who virtually 
decides what risks the company shall take and what 
it shall refuse, and what shall be the specific, written 
terms of the policy. While the company exercises the 

1 From pages 91-103 of Report of the Joint Committee of the Senate 
and Assembly of the State of New York appointed to investigate . . . 
the Affairs of Insurance Companies, etc. Assembly Document No. 30, 
February, 1911. 

323 



324 YALE READINGS IN INSURANCE 

right of review, it is manifestly necessary that it should 
in the main rely upon the judgment of its agents. 
The character of a -company is therefore very largely 
determined by the character of its agents. It is in 
their power to make or ruin a company's business. 

The agent is the one who comes in direct personal 
contact with the insured, the company never. Fur- 
thermore, business is usually done by the insured with 
the agent on a purely personal basis rather than 
because he represents some particular company. The 
property owner gives his business to an agent whom 
he knows and in whom he has confidence and in gen- 
eral lets him select the company that he will place it 
in. The fact that the agent has this personal clientele 
puts him in the position virtually of controlling a 
certain amount of business; as a matter of fact and 
as a matter of law, the business belongs to him rather 
than to the companies; it has been decided by the 
courts, for instance, that the expiration books are 
the property of the agent and cannot be claimed by 
the company. 

It will be easily realized then why the agents have 
such a dominant influence. It is they who control 
the business; the companies must come to them for 
business, and in general must come to their terms. 
The companies seek the agents, not agents the com- 
panies, except to a degree in large cities. 

Fire insurance agents occupy a very curious and 
anomalous position. Legally and in fact they are 
agents for the companies and must protect the com- 
panies' interests, but at the same time their personal 
relationship with the insured makes them equally 
solicitous for his best interests. Add to this the fact 
that the agent represents not one but several com- 
panies and that he is called upon to distribute his 
favors among them all, and we have a notable example 
of a man who is serving many masters. That the 



EXPENSE PROBLEMS 325 

system works as well as it does is remarkable, and 
particularly when the equally anomalous condition is 
noticed that in general agents are paid a commission 
upon the premium receipts, so that a large volume of 
business, and particularly of hazardous, high-rated 
business, is for the benefit of the agent, irrespective of 
whether the results are favorable or unfavorable to 
the company. 

The tendency is for companies in their competition 
for business to appoint agents, not for their real worth, 
but because of their ability to control business, and 
this even goes so far as the appointment of persons 
who are qualified in no other way, persons who, be- 
cause of their connections or because of the sympathy 
they command for some misfortune, can turn over 
certain lines. 

When one considers the very responsible position 
of an agent, not only in binding the company, but in 
consideration of the fact that it is in his power, if he 
is ignorant or careless or otherwise wrongly disposed, 
to write policies for his clients which will not properly 
protect them, the bad economic effect of the appoint- 
ment of incapable agents is apparent. 

Not only, however, do companies appoint agents 
who are not properly qualified or who have no quali- 
fications beyond the fact that they can control a certain 
amount of business, but the tendency is to multiply 
agencies beyond the point where they serve an economic 
purpose, and to a point where they exist for purely 
competitive reasons. In other words, this is an in- 
stance where competition serves no useful economic 
end. 

We may consider competition to mean a state in 
which sellers are trying to attract buyers, and if the 
competition is open there is no bar to this. The 
inducements offered may be of various kinds; in the 
first place the inducement may be a reduced price. 



326 YALE READINGS IN INSURANCE 

This inducement is not made unless the buyers are 
in a position to understand and take advantage of it. 
In the recent investigation of life insurance, it was 
found that competition had not acted to reduce prices, 
for the reason that the real price was largely dependent 
upon the dividends paid, and this was so technical a 
matter that it was not understood by the insured. In 
life insurance competition is turned in other entirely 
different directions. 

In fire insurance, on the contrary, open competition 
has acted, as we have seen, invariably to a reduction 
of rates beyond a point that was to the best interests 
of either insurer or insured. The result has been that 
either by agreement or otherwise prices in fire insur- 
ance have been to a degree standardized and com- 
petition in that direction to that extent limited. 

Inducements, therefore, of some further kind must 
be made. Now in fire insurance the business is con- 
trolled, as we have seen, by the agents. The com- 
panies, therefore, instead of trying to influence the 
insured make inducements to the agents. These 
inducements are of course mainly high commissions. 
In addition to this, however, the companies, as has 
been said, try to induce business by appointing more 
agents than are necessary and agents that are not 
really competent. 

Competition, therefore, in fire insurance has acted 
badly both as regards rates and expenses, but in differ- 
ent ways. It has driven rates too low and expenses 
too high. And just as the companies have combined 
to raise rates to a proper level and to standardize them, 
so the more conservative companies have combined 
to lower commissions and to standardize them. The 
so-called Eastern Union in this territory and the West- 
ern Union in the Middle West limit their members 
to a definite scale of commission. It should be said, 
however, that certain of the largest cities are not 



EXPENSE PROBLEMS 327 

included under the jurisdiction of these bodies; they 
are called excepted cities. 

In the Eastern Union territory the commission paid 
has been a flat 15 per cent. In the Western Union 
territory there has been a graded scale of 25 per cent, 
on preferred risks, 20 per cent, on brick mercantile 
buildings, and 15 per cent, on other classes. In the 
excepted cities the commissions are open; in general 
they run much higher than in Union territory, in some 
cases as high as 45 per cent. 

The membership in the Unions consists in general 
of the strongest, most conservative companies. The 
non-Union companies outnumber the Union com- 
panies, but in amount of business done the Union 
companies are much in the lead. 

The non-Union companies are with few exceptions 
companies that are so weak as to be unable to procure 
the best business without offering some inducement 
either to the policy-holder in a reduction of rates 
(the non-Union companies are largely non-Board 
companies also) or to the agent in an increased com- 
mission. In the case of preferred risks this compe- 
tition becomes intense and often leads to commissions 
that are absurd. In fact, competition on "preferred 
risks" among the non-Union companies has gone so 
far as to drive them, in Western Union territory, into 
a " non-Union" union, called a " Bureau," with a scale 
of commissions somewhat higher than that of the 
Union companies. 

In general the Union companies have been able 
fairly well to meet the competition of the non-Union 
companies, the advantage of their greater strength 
more than offsetting the inducements offered by their 
competitors, but in the Eastern Union territory the 
competition has recently become so intense that the 
Eastern Union has been on the verge of dissolution. 
It has been saved only by yielding to the pressure of 



328 YALE READINGS IN INSURANCE 

the agents and raising its commissions to a graded 
scale similar to that of the Western Union; at the 
same time, however, steps have been taken to reduce 
commissions in the excepted cities. 

The whole subject of commissions is a very per- 
plexing one; it is a matter which is in a continual 
state of agitation between the companies and the 
agents; the companies admit that conditions are 
wrong, but they profess to be at a loss to know how to 
better them, and many underwriters go so far as to 
suggest that it may be necessary for the State to limit 
commissions in fire insurance as it has limited com- 
missions in life insurance. An impartial observer, 
however, is moved to ask, since it is granted that most 
of the trouble about commissions is due to preferred 
risks, why the companies should not stop hacking at 
superficial evils and attack the root of the matter by 
reducing the premium rates on " preferred risks;" 
to satisfy the public that they are thoroughly in 
earnest in their undoubted desire to reduce the ex- 
penses of the business this step must be taken. 

It is strongly contended by many underwriters that 
the high commissions paid on preferred risks are not 
too high; that the business, which is mostly dwelling- 
house risks, comes in such small pieces and is in other 
ways so difficult to write that it should be paid a higher 
rate. There is some justice in this, but it does not 
quiet the matter, for the companies by offering higher 
commissions on this class are responsible for the 
situation, not the agents by demanding them. 

It is possible that in some cases, at least, the com- 
missions on preferred business are not too high, but 
nevertheless they are, in the way that they have come 
about, a clear indication that the business is rated 
too high. 

The making of the rates equitable on all classes and 
hence the elimination, so far as that is possible, of the 



EXPENSE PROBLEMS 329 

"pref erring 7 ' of any one class would perhaps not solve 
the commission problem, but it would certainly go 
some distance in that direction. 

The proposal to limit commissions by law should 
be kept as a last resort. There is an intimate relation 
between rates and commissions, but of the two the 
subject of rates is more fundamental. Rates are 
getting steadily more equitable; furthermore, the fire 
insurance business is changing now very rapidly; time 
should be given to see whether the further progress 
of rate equalization and the rapidly changing condi- 
tions and spirit of the business will not bring improve- 
ments in the matter of commissions. If this is not 
accomplished it would certainly be within the proper 
function of the State to see that this expense is regu- 
lated by law. 

In this connection the subject of contingent com- 
missions should be spoken of. Theoretically it seems 
entirely wrong to pay an agent a flat commission upon 
premiums, because by this system of payment he fails 
to have his interest identified with the interest of the 
company and the public in the prevention of fire loss. 
He gets his premium whether the risk burns or not, 
and in fact to a degree an occasional fire helps his 
business by bringing to peoples' attention the need of 
insurance. As to the actual workings of the system 
only this can be said: there are all kinds of agents as 
there are all kinds of men in general; some are very 
careless about writing risks, some are very careful. 
But on the whole agents are not interested in fire 
prevention to any such degree as the companies. 

This seems radically wrong, for no one touches the 
problem of fire prevention so intimately. It has been 
proposed to force an interest in the agent in fire pre- 
vention by making part of his commission contingent 
upon the earnings of the company upon the business 
which he has written. In fact one large and prosper- 



330 YALE READINGS IN INSURANCE 

ous company already pays many of its agents upon 
this basis. Some few objections have been made to 
this plan, but none that seem important. The plan 
of paying agents contingent commissions was endorsed 
by the last Convention of Insurance Commissioners. 
Your Committee does not recommend legislation 
upon this subject, but thoroughly commends the prin- 
ciple of contingent commissions and believes that it 
should be put into general practice by the companies. 1 
The expense problem is unquestionably the most 
perplexing problem in the business to-day. It is seen 
that the tendency of free competition is to drive com- 
missions higher and higher, and it is difficult to see 
what will restrain this tendency except combinations 
of the companies to regulate commissions. Such 
organizations then as the Eastern Union should be 
encouraged. 2 In addition to the expense that arises 
from high commissions we have also seen that there 
is a waste in the business produced by too great a 

1 It has not been made clear how contingent commissions could be 
made to operate fairly as between the several companies in a single 
agency. "In every agency a part of the companies are reasonably 
certain to have enough losses each year to place them out of the cate- 
gory of contingent earners for the year, but the agent can still get ten 
per cent, commission from these companies for risks he would hesitate 
to place with his contingent earners. This creates a motive on the 
part of each agent to discriminate among his companies, and this 
motive is cumulative in the fact that it increases toward the end of 
the year with the growth of the accrued contingent due him from 
companies that have had no losses. As the end of the year approaches, 
this accrued contingent in a single company may become a hundred 
times as large as the commission on a single questionable risk, and the 
motive grows day by day to coddle the contingent earners by giving 
them all the choice business, and by giving the questionable risks to 
the companies that have ceased to be contingent earners but still 
are commission earners." On the "commission problem" cp. Dean r 
" Rationale of Fire Rates," 1901, pp. 153-165, from which the above 
passage is quoted. W. H. P. 

2 Curious to say, however, in some states companies are denied the 
right to combine even on the subject of commissions. 



EXPENSE PROBLEMS 331 

number of agents and particularly by the appointment 
of agents who are incapable of performing any real 
economic service. 

The companies show no signs of taking any steps 
to improve this latter condition. The better class 
of agents, however, through their organizations, are 
moving in this matter, not so much for the good of 
the public as for the sake of better conditions in the 
business itself; it has been freely suggested by agents 
that the State should undertake to protect the public 
from incompetency in this field. Certainly if the 
State finds it desirable to go so far as to set up a stand- 
ard for veterinary surgeons and for plumbers it is 
reasonable that it should set up a standard for the 
agent who, by carelessness or incompetence, can inval- 
idate his client's insurance or plunge the companies 
into severe losses. It would seem desirable that an 
examination for competency should be provided by 
statute or that the Superintendent of Insurance should 
be empowered to fix standards of competency and 
license only those who are able to comply therewith; 
furthermore, that a fee should be charged. This 
would help to reduce the number of unnecessary agents, 
particularly if the fee were large. It is doubtful, how- 
ever, whether as a practical matter the State could 
go very far in this direction without bringing into 
operation the retaliatory laws of other states to the 
disadvantage of domestic companies. 

One other aspect of the expense problem must be 
spoken of. Attention has already been called to the 
fact that the tendency in insurance is now very strongly 
toward " prevention. " In one field, steam boiler in- 
surance, this has gone so far that the preventive work 
of the companies has become far more important 
than insurance proper. It is so obvious that the 
blowing up of boilers should be prevented rather than 
that they should be allowed to blow up and the losses 



332 YALE READINGS IN INSURANCE 

distributed that as a matter of fact over 80 per cent, 
of the premiums are used for inspection and other 
preventive work. 

It ought to be almost equally obvious that fires and 
deaths should be prevented; we are accustomed, how- 
ever, to think of them both as inevitable; death is 
inevitable, to be sure, but not untimely death; we 
are coming more and more to know that fire and dis- 
ease should both be eradicated. 

Now in the face of this tendency the question of 
expense, serious as it is now, is a still more serious one 
to meddle with. For if it is really true that the 
destiny of insurance is to become prevention, as steam 
boiler insurance has become, the expense ratio must 
increase instead of diminish, namely by all the expense 
of inspections and other preventive work. Arbi- 
trarily then to limit expense would be a very danger- 
ous step, for it might discourage this very development. 

The fire insurance business is characterized by its 
great variety of local conditions; the same company 
often does business very differently in different states, 
and even in different parts of the same state. It is 
impossible, for instance, to treat the broker in fire 
insurance in a general way; in one part of the country 
he is looked upon as an unmixed evil and in another 
part he has made for himself a thoroughly honorable 
and useful place. 

It is evident that there must be middlemen between 
the company and the insured. In the country and 
small city these are the local agents; in some of the 
larger cities also the business is entirely in the hands 
of the agents and their paid solicitors, but in most of 
the large cities there has grown up, to a greater or less 
extent, a class of " brokers'' who bring the business of 
their clients to the companies. The agent and the 
broker are largely complementary, that is, the presence 
of one to a degree usually means the absence of the 



EXPENSE PROBLEMS 333 

other. In New York City, for instance, business is 
done almost wholly through brokers and there are but 
few local agents. 

It is impossible in large cities for the insured to come 
into direct contact with the company; whether the 
middleman is the agent (and his paid solicitors) or 
the broker is, in an economic sense, largely a matter 
of indifference, provided both are efficient — that the 
work of each is a real service. 

Fundamentally the broker is one who can control 
a line of insurance; he virtually sells it to the com- 
pany; his pay is in the form of a commission. If 
this were the whole of the service that the broker per- 
formed (and in some cases it is hardly more than this) 
his existence would hardly be justified; at best the 
only economic service that he performed would be 
the covering of some property with insurance which 
would otherwise be allowed to go unprotected. 

The broker has, however, in general developed to a 
point several steps in advance of this. Competition 
for business has forced him to find ways to make 
himself useful. That broker will get the most business 
who can give the most value in return. 

Now, in a large city where the insurable values are 
large, where the conditions are complex, where the 
rating is done by schedule, where enough good insur- 
ance is difficult to find, it is not hard for the broker 
to find valuable services that he can acceptably per- 
form. They are much the same services which, in 
the absence of brokers, would be performed by agents. 
He becomes the expert adviser of the insured, he in- 
spects his property, he studies his schedule, he finds 
what changes can be made to reduce his rate, he plans 
these changes in detail, or if the building is still in the 
hands of the architect, he joins with the architect in a 
study to make it a superior risk, he decides the written 
part of the policy and the appropriate forms, he picks 



334 YALE READINGS IN INSURANCE 

out the companies to whom the risk is to be given, he 
gives legal advice, he attends to adjustments of losses 
— all of these services and perhaps others are per- 
formed by the brokers who have the most successfully 
found their place. 

In all of this the broker is acting as agent for the 
insured (although he is paid by the companies). It 
can hardly be denied that one who has found as much 
work as this to do has justified his existence. And 
there is perhaps a certain advantage in his representing 
the policy-holder instead of the company, for it is be- 
yond question that the man who has large insurable 
interests needs this expert advice. 

But to perform these services requires the employ- 
ment of a large office force and a number of experts, 
and so, either as cause or effect, it has happened that 
in general it is the larger offices that can offer the most 
capable service. The brokerage " evil " has to do not 
with this class but rather with those who are hardly 
more than solicitors. There are about 7,500 brokers 
that are certificated by the New York Fire Insurance 
Exchange ; of these probably 5 per cent, do most of 
the business. Do the remaining 7,000 perform any 
really important service for the public ? If not, had 
the majority of them not better be eliminated ? 

It is not true, to be sure, that the support of these 
falls entirely upon the insurance business, for most 
of them combine their insurance with real estate or 
something else. It is not an easy question to dispose 
of. Even granted that a number of members of a 
community are out of place economically, it is quite 
another question to know the wisdom of whether and 
how to try to put them right. Even if these brokers 
were eliminated as brokers, would they not turn up as 
paid solicitors in the offices and things go on in much 
the some way? 

However, what has been said about the qualifica- 



EXPENSE PROBLEMS 335 

tions of agents applies almost as strongly to brokers. 
This committee believes that it is desirable that the 
State should fix a standard of competence both for 
agents and brokers; furthermore, that a broker should 
be required to pay a license fee to the State. 

Brokers occupy a somewhat anomalous position in 
that they are agents of the insured and yet are licensed 
and paid by the companies. Trouble has often arisen 
from this fact. The policy-holder has found himself 
unprotected because of failure of his broker to turn 
over his premiums to the company; furthermore, it 
is often impossible in the case of cancellations for the 
companies to obtain return commissions from the 
broker. To correct this there have been several 
proposals; one way to handle this matter would be 
to require a bond from the broker, another way would 
be to make the broker, as a matter of law, the agent 
of the company. 

At first glance the idea of requiring a bond of the 
brokers for the faithful performance of their duties 
recommends itself, but on a closer examination the 
question arises, why single out one form of occupation 
and require it to be subjected to restrictions of this 
nature when the State does not require anything of the 
kind in other professions where a license is necessary 
and where the fiduciary element is present to a still 
greater degree. 

For example the State licenses attorneys-at-law, and 
it is a matter of common knowledge that these men 
are called upon to handle their clients' or principals' 
money in large amounts. No undertaking is required 
of them that they will be honest before the authority 
is granted them to practise their profession. Such 
matters are left to be taken care of by the penal stat- 
utes, and the committee believe that this is as it should 
be. If provision is made to license the broker and one 
of the conditions for the granting of the license is that 



336 YALE READINGS IN INSURANCE 

he must be trustworthy, and if it is made easy for such 
license to be revoked upon its appearing that he has 
ceased to be such, and if his conviction is made possible 
for any form of dishonesty or on proof that he has 
violated the insurance law, or even on proof that he is 
guilty of such sharp practices as to make him untrust- 
worthy, it would seem that the object sought in the 
suggested bond requirement had been amply attained. 

The committee has endeavored to cover this very 
point in a statute which will be submitted, and to 
cover it in such a way as to eliminate the dishonest 
broker without doing violence to the principles of 
good public policy. 

The principle that your committee has acted upon 
in its conclusions is that the State should go no further 
in the regulation of insurance companies than actual 
conditions seem to demand. Free competition should 
be considered to be the normal basis, in general, for 
business activity. If, however, it should be demon- 
strated that this condition is leading to grave abuses 
it would be the function and duty of the State to inter- 
fere; it is an open question, for instance, whether the 
State will not find it necessary some time to regulate 
commissions. 

When, however, the companies leave the condition 
of open competition and form combinations, it is 
recognized that the State may rightly take steps to 
guarantee to the public that this power that the com- 
panies so gain shall not be abused. Your committee 
goes a step further than to provide merely for publicity; 
it is prepared to recommend that combinations of 
companies should not be allowed to exercise a control 
over brokers. The correctness of this principle is 
open to argument. The committee, however, feels 
very strongly that the pledges that are now required 
by rating organizations of brokers give to such combi- 
nations of companies powers which, if they are to be 



EXPENSE PROBLEMS 337 

exercised at all, should belong to the State. Such 
pledges now give to the Exchange a life and death 
power over the broker and furthermore make him an 
important instrument in carrying out the purposes of 
the combination. It may be granted that in general 
these purposes are good, and yet it is offensive to one's 
sense of liberty that this power should be in the con- 
trol of a combination to be exercised not upon the 
agents of the companies but upon the agents of the 
insured. 

It is believed that the good of the business demands 
combination, but this combination must not be main- 
tained by a control over a non-participating outside 
element. Whatever powers are necessary to secure 
the proper activity of the broker should be assumed 
by the State. It might be well, however, that in the 
exercise of this power the Exchanges should be called 
upon in an advisory capacity. 

Commissions to brokers are paid out of the pre- 
miums by the companies. If it is granted that brokers 
are performing a valuable expert service for the insured 
it would seem natural and desirable that they should be 
paid by the insured for the service performed just as 
lawyers are paid ; of course, it is in the end the insured 
that pays the broker, even if as now he pays him in- 
directly through his insurance premiums. It is doubt- 
ful, however, whether the payment of the broker 
directly by the insured could be made to work. Theo- 
retically it would be much better, for it would stop 
rebating. In that case every man would pay the same 
price for his insurance (he should, of course, get it 
for the regular price less the regular commission to 
brokers), but he would make his own bargain with his 
broker. At present the insured are all on the same 
terms both as regards the cost of their insurance proper 
and that part of the premium that goes to the broker. 
The practical consequence of this method of payment 



338 YALE READINGS IN INSURANCE 

is that some brokers buy their business by giving 
rebates. 

That one man should be able to get the service of 
his broker more cheaply than another (which is what 
a rebate amounts to) is not wrong; it is purely a com- 
petitive condition that in a majority of cases would be 
founded on reason, but that it should be accomplished 
by the passing of a rebate is what is reprehensible. 
In the one case the bargain with the broker is open and 
straightforward, in the other case it is indirect and 
underground. 

As a practical matter rebating in any form works 
badly. It is a form of discrimination in which a 
straightforward man is at a disadvantage. Practically 
all of the underwriters' organizations attempt to 
prevent rebating; the New York Fire Insurance 
Exchange, for instance, requires from every broker a 
pledge not to rebate, the penalty being the revoking 
of his license. If such a pledge as this is broken, and 
assertions are freely made that this is not uncommon 
in New York, the discrimination is all the more marked, 
for now it is not merely the straightforward against 
the underhanded, but the honorable against the dis- 
honorable. 

If rebating is a really serious evil and if the payment 
of brokers by the insured is impracticable, the matter 
should be assumed by the State and an anti-rebate 
law should be passed to govern both agents and brokers. 
While this would not absolutely cure rebating it would 
go further than the underwriters themselves can go 
in the matter. 



CHAPTER XVIir 

CONFLAGRATION RESERVE 1 

It did not need the San Francisco fire to call to the 
attention of insurance men the importance of the subject 
of the conflagration hazard; it was a vital question already, 
in fact it had been only a few months before that an elab- 
orate report on the conflagration hazard of San Francisco 
had been issued by the National Board of Fire Under- 
writers, being one of a series on the large cities of the 
country. But to the insured the conflagration hazard 
was a very vague idea, not definite enough to prevent 
him from grumbling at paying premiums that were larger 
than what were needed barely to pay ordinary losses. 
It seems an opportune time to discuss the subject of the 
conflagration hazard — what the companies may reason- 
ably do, and what the insured may do to safeguard his 
rights. 

The rate in fire insurance is designed to cover, first, 
the fire hazard, second, the expense of doing the business, 
and third, the profit. The fire hazard is of two kinds, 
first, the hazard of ordinary fires in which one or a few 
buildings are burned, second, the conflagration hazard. 
The two things are practically distinct in spite of the 
difficulty of drawing the line between them. If the con- 
flagration hazard were eliminated not only would a large 
part of the premium be cut out, but the business of fire 

1 By A. W. Whitney. Reprinted from pages 42-50 of a " Report 
of the Special Committee of the Board of Trustees of the Chamber 
of Commerce of San Francisco, 1906." 

339 



340 YALE READINGS IN INSURANCE 

insurance would be one of great steadiness. For with a 
multitude of risks the fluctuations would be relatively 
small and would be due mainly to general conditions that 
affect all business in much the same way. It would then 
be unnecessary for companies to hold large surpluses. 
Such, for instance, would be the condition of a company 
which wrote business only in the country. 

In spite of the fact that fire insurance is usually a pri- 
vate enterprise there is no more fundamental fact than 
that the companies stand simply as agents of the insured. 
That is, instead of the company insuring its policy-holders, 
the policy-holders really insure each other, and the com- 
pany simply manages the details of the transaction. In 
insurance there are no values created, they are only dis- 
tributed, and whatever the company distributes must be 
collected. 

There could be no insurance if there were not a large 
number of the insured. There must be a large enough 
number of the insured to furnish an average that will be 
free from large fluctuations year by year. For ordinary 
fires this may be obtained in a small section of the country 
and even in a single city. For instance, if there were no 
danger of sweeping fires a company might very safely 
write business in San Francisco alone. 

So much for the ordinary hazard, but the conflagration 
hazard is of an entirely different character. Here the 
inhabitants of no one city could constitute the insurers, for 
a conflagration might sweep them all down. The insurers 
must be taken to be the inhabitants of many cities, as 
many in fact as can be found for which the conflagration 
hazard is nearly the same. But still the average is not 
obtained, for even in all the large cities of the country 
together, conflagrations do not occur in any regular way 
year by year. It is necessary, therefore, to take not any 
one year but a long series of years in order to obtain the 
necessary average without which there can be no real 
insurance. But even then the average is far from stable; 



CONFLAGRATION RESERVE 341 

the San Francisco conflagration in three days did more 
damage than all the other large conflagrations in this 
country for the last forty years. The only conclusion 
then is that it is impossible to have any such perfect 
insurance against conflagrations as against ordinary 
fires. Insurance is a wonderful institution, but there are 
limitations to its usefulness. 

These considerations have a practical bearing. The 
part of the premium that is collected to meet the hazard 
of ordinary fires is expended during the year, the year 
being in general sufficient to furnish an average, the com- 
pany being required to hold as a liability the part of the 
premium that is still unearned. The part of the pre- 
mium, however, that is designed to meet the conflagration 
hazard will not in general be expended during a single 
year, but must be kept perhaps for many years till the 
occasion arises for its use. This fund is called the sur- 
plus, but very unfortunately; it should be called the con- 
flagration reserve and should be treated as a liability, 
just as is the reinsurance reserve. Surplus is something 
"over"; this is not "over," it is held for a definite purpose 
and hence is a strict liability. This is not a quibble over 
names, it is an attempt to demonstrate the accountability 
of a company as regards its surplus, the surplus being in 
reality contributions of the policy-holders against con- 
flagration. 

Admitted then to be a liability, what should be its 
amount? There are two methods conceivable for its 
determination, the retrospective and the prospective 
method, just as in life insurance. The retrospective method 
analyzes the premiums into a charge for ordinary fires 
and a charge for conflagrations; this would be very 
good in order to ascertain what the annual increase of 
the surplus should be. But the prospective method gives 
the real criterion of its size. The "average" failing to 
exist in any reasonable time, the size of the conflagration 
reserve cannot be based upon what is necessary to meet 



342 YALE READINGS IN INSURANCE 

the "average" conflagration, but instead must be based 
on what is necessary reasonably to meet a " worst" con- 
flagration, that is, the size of the required surplus shall be 
determined by the amount of the aggregate risks that are 
exposed to a single conflagration. 

To summarize then, surplus should be treated as a 
liability and its amount determined by a reference to the 
aggregate risks exposed to a single conflagration. A 
company's business then in a single city must be limited 
not necessarily to exactly the amount of its surplus, for 
practically there is not enough insurance to be had to 
make this possible, but it should have some definite ratio 
to its surplus. But how is a new company to get a sur- 
plus? In either of two ways, start small and grow big, 
or else put up the surplus in the beginning. And here is 
the function of the stock company rather than the mutual 
company. The insurance principle proper breaks down 
when it comes to dealing with the conflagration hazard and 
requires a boost from something else, namely, private cap- 
ital that is willing to assume risk for the sake of gain. 
Pure insurance, only where there is a proper average, may 
be entirely mutual as life insurance and fire insurance in 
the case of well scattered risks. 

A new company then which desires to write business 
exposed to a conflagration hazard must put up a surplus. 
As the business develops and the surplus grows, the 
company may take on a growing amount of city business. 
If the company should desire to write less city business 
at any time or to retire altogether, part or all of the sur- 
plus would be freed from its character as a liability and 
would be at the disposal of the company. 

The result arrived at is no strange thing. It is nothing 
but what has occurred to every thoughtful person who has 
known the insurance situation following a conflagration. 
It is simply an insistence upon some commensurateness 
between the resources of a company and the amount at 
risk in a region subject to a single conflagration, an attempt, 



CONFLAGRATION RESERVE 343 

therefore, to prevent companies with a capital and surplus 
of $250,000, but with an energetic agent, from assuming 
the conflagration risk that belongs to a company of ten 
times that size; namely, in this case the companies that 
are now able to pay only 30 to 60 per cent. 

You may say, leave such companies to perish of their 
own egregious intemperateness; that would do very well 
if it were the company only that suffered, but the greatest 
sufferers are the policy-holders. There is, to be sure, the 
eventual action of the law of the survival of the fittest, 
and if insurers were intelligent enough and well-informed 
enough this would be better than legislation. 

Before you go into a theater it would be well if you 
were able yourself to examine into the safety of the build- 
ing; since that is out of the question the next best thing 
is a building law. 

It is almost equally difficult personally to know the fit- 
ness of an insurance company to assume a risk. In view 
of the impracticability of doing this, the next best thing 
is a law regarding liability. There is a law regarding 
liability for the unearned current premium, there ought 
to be a law regarding liability for unearned conflagration 
accumulations. 

Now it is only fair when funds to meet a potential liabil- 
ity have been provided in a prescribed manner that this 
measure of the potential liability should be taken after 
the loss has occurred as a measure of the actual liability. 
That is, if a company has maintained its conflagration 
reserve, its liability in case a conflagration has occurred 
should be limited to this amount. This being a part of 
the contract introduces no element of unfairness; the 
insured, instead of buying insurance with theoretically 
unlimited liability, but practically most decidedly limited 
because of the well-known expense and delay of litigation 
and the undesirableness of receiverships, buys insurance 
in which liability is definitely and legally limited; but the 
protection is standardized. 



344 YALE READINGS IN INSURANCE 

This again is not a matter of far-away theoretical inter- 
est; it is vitally connected with the actual situation in 
San Francisco. No fact has been more striking than that 
practically the liability of the companies has been limited. 
In spite of the fact that companies could be brought into 
the courts and compelled to pay their claims in full or be 
driven into acknowledged insolvency, in spite of the fact 
that there is a state law regarding stockholders' unlimited 
liability, it is a most notable fact that but three companies 
are in the hands of receivers, that more than half the 
companies have been able to settle their claims at less 
than their face value with few lawsuits, that companies 
which have paid but 50 and 60 per cent, are likely to be 
able to close out their claims and yet preserve their plants. 
This is a state of actually limited liability. Which is the 
better, theoretically unlimited liability with such an attend- 
ant host of disagreeable features as we have had in San 
Francisco, amounting as a matter of fact to limited liabil- 
ity, or a legally limited liability with standardized pro- 
tection? 

Nothing is gained by taking the pound of flesh. To 
drive a company into insolvency and thereby destroy its 
plant is to kill the goose that laid the golden eggs. Set 
a reasonable standard of protection against conflagration, 
then if this has been observed absolve the company from 
further liability. The company will then have saved its 
plant and may immediately go on in business on whatever 
scale its remaning funds or fund to be put up by its stock- 
holders will warrant. 

The details of such a plan can manifestly not be given 
here, but it is perfectly possible to work them out in an 
entirely practical, consistent way. To sum up, however, 
the advantages of such a plan are, first, no company could 
write an inordinate amount of business and so nullify its 
capacity to indemnify; second, there would be better, and 
not only better, but standardized, protection against 
conflagration; third, the business of fire insurance with 



CONFLAGRATION RESERVE 345 

this element of uncertainty removed would be far more 
attractive to capital and would appeal to a better class 
of investors. 

This, by the way, might apparently seem to be dictated 
by a thought of what would be best for the companies. 
Not so at all. The fundamentally mutual character of 
insurance is so dominant that the company is almost lost* 
sight of. As a matter of fact what is best for the insured 
and what is best for the company are in any large matters 
identical. 

One point more; it may be said that a law of the kind 
proposed would work a hardship upon the small com- 
pany. No great hardship; a small company may do as 
much country business as it pleases, and it may take a 
share of city business proportionate to its size. To attempt 
to minimize the advantage of size in fire insurance is 
ridiculous. Nowhere else is it more true that "to him 
that hath shall be given"; it reads: "to him that hath a 
large surplus shall be given much city business and from 
him that hath not shall be taken away (by reinsuring it, 
if a company can be found to take it) most of that which 
an over-energetic agent has written." 

And now let us come back to the immediately practical 
business as it is to-day. Massachusetts, which has always 
been the leader in intelligent insurance legislation, had a 
law a few years ago limiting the amount of risk that a 
company might assume in any one of certain districts in 
Boston. This law was repealed. It was presumably 
found that with the law in operation it was impossible to 
obtain enough insurance, the reason of course being that 
while the legally prescribed limit would have yielded as 
much insurance as before, as a matter of fact the conserv- 
ative companies would not write up to the limit allowed. 
There was, therefore, a deficiency of, to be sure, a very 
poor type of insurance, namely, one that gave practically 
no protection against conflagrations, but nevertheless it 
gave fairly good protection in the case of ordinary losses, 



346 YALE READINGS IN INSURANCE 

and for this purpose, in the lack of anything better, could 
not be spared. 

This, then, apparently disposes of the practical possi- 
bility of placing a limit upon city risk. Yes, absolutely, 
in large cities if the supply of insurance is to be always 
limited to what is available now. But the one hope of 
bettering insurance protection against conflagrations is 
the enlistment of more insurance capital, and the one 
way of doing this is to make the business more attractive. 
A limited liability law would do this. As a matter of 
fact the safety-fund laws of various states, New York 
among the number, are exactly of this nature, but if 
the liability is to be limited, the simplest, most natural 
limit seems to be had by a reference to the aggregate 
amount exposed to a single conflagration as outlined 
above. 

Still, as a matter of fact, whether liability should be 
limited to the surplus, the surplus and capital, or to the 
surplus, capital, and the excess of the unearned premium 
reserve over the actual cost of reinsuring the outstanding 
risks is a matter of detail; the important thing is to grant 
some form of limited liability in case of conflagration that 
will save the plant; but it should be granted only if there 
is the proper commensurateness between the conflagration 
risk and the company's assets. 

Is it worth while to think of conflagrations or do they 
come so seldom that we may go on in sweet oblivion? Is 
the insurance business to be organized with the possibility 
of a conflagration clearly recognized or is it to be based on 
ordinary loss, and Heaven help us if we have a conflagra- 
tion? A conflagration may be a theory in New York, but 
it is a fact in San Francisco. The conflagration hazard, 
basing it upon the three large conflagrations of the last 
fifty years, excluding the San Francisco conflagration, 
and spreading it over the twenty largest cities of the 
United States, can be demonstrated to have been (on the 
assumption that the rates have been adequate), on mer- 



CONFLAGRATION RESERVE 347 

cantile stocks half as large as the ordinary hazard, and 
on so-called fire-proof buildings several times as great as 
the ordinary hazard. This does not appear to be a haz- 
ard that should be neglected. 



CHAPTER XIX 

FIKE INSURANCE ENGINEERING 1 

Fire insurance engineering is the application of the 
principles of engineering to prevention of fire, to protection 
against fire, and to arrangement of property so that the 
least possible damage will result when fire occurs. 

As now practised it is the outcome of many years of 
evolution from the need of fire insurance companies, 
but principally during the last twenty years. Although 
there are many capable men in the business who are not 
graduates of any college or technical school, a large and 
increasing percentage is composed of graduates, usually 
of the technical schools, because the studies there deal 
directly with the application of the principles of engineer- 
ing and chemistry inseparably connected with this work. 

All over the United States and Canada, to speak of the 
territory to which most of the American companies con- 
fine their operations, the companies maintain organiza- 
tions for estimating rates, or for inspection to improve 
risks, work which requires the examination of insurable 
property of every sort by men in their employ who make 
this a specialty. Entrance to the profession is usually 
effected by becoming an inspector of this sort at the rate 
of $50 to $75 a month, more often the latter to a scientific 
school graduate, well recommended. In two years the 
average man can earn $1200 a year. After that the sal- 
aries vary too much to give any satisfactory average; 

1 By Frederick C. Moore. An address delivered before the insur- 
ance class in Yale University, May, 1909. 

348 



FIRE INSURANCE ENGINEERING 349 

with equal loyalty and hard work, much depends on the 
good judgment, tact, and initiative of the individual, as 
in other enterprises. Salaries of inspectors commonly do 
not exceed $2500 a year, except when they have some share 
in the executive management. From these inspectors 
are selected those who fill positions at the heads of the 
various bureaus and of the special departments main- 
tained by large companies, which pay larger salaries. 

Although the money reward is not large for the aver- 
age as compared to those of individuals in successful inde- 
pendent mercantile pursuits, and although the vocation 
carries with it the disadvantage of absence from home 
during the greater part of the time, and the necessity for 
starting at short notice so that the plans of ordinary home 
life are almost impossible, the employment is very secure, 
continuous, interesting, and in most associations very 
pleasant, so that few leave the business. 

The novice spends three months or more under the 
instruction of a trained inspector in the field. Ordinarily 
at the end of a novitiate of that length he is able to travel 
alone to do the simpler work, but it is a year before his 
judgment is trained so that he is of much value, and it is 
much longer before his experience is sufficiently varied to 
enable him to work easily and with confidence. 

As there are always more applicants for inspector's 
positions than places, good material for selection is as- 
sured, and the choice being governed in most cases by 
relative merit, the result is a body of men of good character, 
energy, and intelligence. Each is spurred on to greater 
effort by the example of some associate with a better 
record, by the hope of a more speedy increase in salary, 
but particularly by the possibility, ever present and 
never forgotten, of being selected by some fire insurance 
company, large manufacturing corporation, or large insur- 
ance agency or brokerage firm for a position of greater 
responsibility and higher salary. All the manufacturing 
and mercantile risks which are insured are visited by such 



350 YALE READINGS IN INSURANCE 

men, who are privileged by their mission to examine every 
part of the property in detail. 

To illustrate the training which makes insurance engi- 
neers, let us follow the general work of an inspector in the 
employ of one of the large inspection bureaus which make 
a business of reporting the condition of insured property 
to the fire insurance companies. 

He is given a list of properties of every sort to inspect, 
grouped systematically according to locations, and works 
alone. Generally speaking, his absence seldom exceeds two 
weeks. If he goes to Pittsburg, his list may contain an 
open-hearth steel plant, rolling-mill, crucible steel plant, 
rail mill, distillery, window-glass factory, plate glass fac- 
tory, pressed glass plant, rubber mill, department store, 
car works, modern warehouse for general merchandise, 
packing-house, harness leather tannery and others. This 
same interesting variety of subjects is characteristic 
of the work in most places, and is a never-failing source of 
interest to one who is a student of industrial processes. 
To the examination of each of these he applies the 
same principles, prompted to prevent oversight by a 
printed question blank. It is necessary to consider the 
character and influence of neighboring property which 
may expose the risk in question to the danger of a fire 
without, the construction, the occupancy, and the materials 
and processes it entails, particularly with reference to the 
hazards thereof, care and cleanliness, the private and the 
public protection, and any special conditions influencing 
the fire risk, all in detail. Usually he draws a ground 
plan at the first inspection and this is carefully corrected 
at each subsequent inspection. With a good plan and 
report a company can decide what line it will carry. 

It requires from a few hours to several days to make an 
inspection, according to the size of the risk. It will 
therefore be evident that the number of risks inspected 
in a year is not necessarily a comparative measure of value, 
because the skilled man will be given more of the long, 



FIRE INSURANCE ENGINEERING 351 

difficult inspections. For an entire bureau force they will 
not average one per working day per man; in fact, the 
actual performance of one of the largest for last year is .73. 

A good inspector is essentially a good reporter. Those 
who receive the reports prefer to draw their own conclu- 
sions, which are often very different from those of the 
inspector, whose criterion is based on physical conditions, 
while that of the underwriter is probable profit and loss, 
and includes prominently the question of rate, which the 
inspector ordinarily does not know, and is usually specifi- 
cally instructed to disregard in order that any opinions, 
which, in addition to the facts, he is expected to express, 
may not be influenced by the knowledge of the rate. 

The expense of getting this information has resulted in 
the organization of the inspection bureaus already briefly 
mentioned, which have from twenty to fifty companies 
as members, each of which gets all the information. This 
concentration of effort has resulted in the employment of 
a corps of inspectors large enough to have one inspector 
in each district, so that when the need arises for an imme- 
diate examination of any risk the nearest man will be 
only a short distance away and can be sent at once. In 
a day or two thereafter the report is in the office and in 
another two days can be in the hands of the members. 
It costs from 4 to 5 per cent, of the premiums of the risks 
inspected to support a large bureau. The companies 
believe it pays to spend this money, even though there is 
only negative proof, since no one can tell what the result 
would be if inspections were abolished. They certainly 
prevent fires, cause arrangement of risks which diminish 
the average loss and forewarn the companies of conditions 
which lead to loss. These inspections are of value to 
every fire insurance company, because they cause the im- 
provement of the risk whatever companies may write it. 
No less important are the benefits conferred upon the 
owner of the plant. In most cases he desires to know 
what to do to protect his business from the disastrous 



352 YALE READINGS IN INSURANCE 

effects of fire, which not only causes immediate material 
loss, but also serious consequential loss to his established 
trade, which competitors win away while he is rebuilding 
his factory. Consequently he welcomes a thorough inspec- 
tion, and is glad to consider resulting suggestions. Not- 
withstanding the predominance of owners of this type 
there are enough of the sort who meet suggestions with 
the comment, "I suppose you are obliged to find fault to 
hold your job," a bit of cynicism quite unwarranted, and 
which the inspector has heard a hundred times before, so 
that its one-time wit is quite lost. It is noteworthy that 
inspectors are as a class very earnest and honest in their 
work and that they have enthusiastic professional appre- 
ciation for a risk which is above criticism. 

The same inspectors who carry on the work previously 
described also report on every important fire immediately 
after its occurrence. Thus we have full information of 
conditions before and after the fire, and the comparison 
leads to improved conditions not only in the risk affected, 
but also in other risks where similar conditions exist. 

Most of these men are members of an organization known 
as the National Fire Protection Association, formed "to 
promote the science and improve the methods of fire pro- 
tection and prevention; to obtain and circulate informa- 
tion on these subjects, and to secure the cooperation of 
its members in establishing proper safeguards against 
loss of life and property by fire," the publications of 
which may be obtained by any one who is interested in 
the subject by becoming a subscribing member at an annual 
fee of $5. 

This association holds annual meetings which are at- 
tended by large numbers of the field men, and at which are 
presented the rules, specifications, or other findings of 
special committees among which such work is divided. 
Therefore, anything promulgated by the association has 
been subjected to the criticism of men from all parts of 
the field in an open discussion. The result is standards 



FIRE INSURANCE ENGINEERING 353 

for the construction, installation, and use of different 
devices and materials for fire prevention and fire protec- 
tion and the elaboration of methods of fire insurance 
engineering generally. These rules and methods are the 
guides to the engineer in his work with the property owner, 
who will, we trust, recognize that the basis for the sug- 
gested improvements to his risk are principles which are 
the outgrowth of the consensus of opinion at these rep- 
resentative meetings and not simply the result of local 
experience. 

In order that the relative merit of these devices and 
materials may be definitely ascertained from tests under 
conditions which admit of accurate comparisons, the 
companies maintain the Underwriters' Laboratories at 
Chicago, where tests and investigations are carried on with 
the cooperation and advice of committees of the National 
Fire Protection Association, in consideration of a fee 
paid by the applicant for the test, which covers part of 
the expense of the work. The benefit to the applicant, 
who is practically always the owner of something which 
he expects to sell to the public, is that if his product is 
successful under test he receives the approval of the 
laboratories, which gives the article a better position in 
the eyes of buyers. To insure that the entire product 
will be the same as the samples approved by test, a plan 
to inspect the product at the factory has been put into 
effect, the theory being that a particular label attached 
thereto will be conclusive guarantee of the proper stand- 
ard of excellence. 

The tests have been made principally upon electrical 
devices and materials, fire-extinguishers, hose, fire-doors, 
and shutters, automatic sprinklers, and allied devices, 
lighting and heating devices, and structural materials of 
various sorts, carried on along the lines of physical lab- 
oratory testing, but always with an eye to practical con- 
ditions. For instance, a fire-door or shutter is set in a 
brick panel forming one side of a gas furnace capable of 



354 YALE READINGS IN INSURANCE 

generating a temperature, gradually raised to 1800° to 2000° 
F., about 1000° being reached in the first five minutes. 
After an hour's exposure the side of the furnace carrying 
the shutter is slid rapidly to one side into the open yard, 
and a hose stream directed against the heated side, repro- 
ducing the extreme conditions of actual use. The defects 
of the shutter are certain to show. The thoroughness of 
this test is indicative of the methods used generally. 

The information developed by field work and by the 
laboratory tests is being applied to bring about better 
construction particularly, which is probably the most 
important condition in limiting fire loss. 

One of the most serious handicaps to the successful 
operation of fire insurance companies is the spread of fire 
from one building to another, developing in the extreme 
into conflagrations such as those from which the country 
has severely suffered in the last few years, and in which 
fire-proof buildings, of construction so good that the funda- 
mental parts of them withstood the fire, offered no real 
barrier. This is largely due to the absence of protection 
for the wall openings, and to educate the public to the 
need for such protection is one of the most urgent duties 
of the insurance engineer. Obviously, all buildings can- 
not be fire-proof, but even on brick buildings of ordinary 
construction the general protection of the exposed win- 
dows would result in enormous decrease in the exposure 
losses, which, leaving conflagrations out of the question, 
are very heavy in the aggregate. By some fallacious 
reasoning it has been the unfortunate custom to omit 
protection on windows which face streets, but ordinary 
streets offer no effective stop to flames. By giving the 
fire department time to work before a fire can reach more 
fuel, the protection of wall openings will do more than any 
other structural change to prevent conflagrations. 

A study of this question of exposure leads an American 
to envy the condition in France, which is such that a 
Napoleonic law can exist that compels an owner to pay 



FIRE INSURANCE ENGINEERING 355 

damages caused to neighboring property by fire origina- 
ting on his premises, and to admire the construction that 
makes it possible for insurance companies to insure that 
liability for a merely nominal rate. 

Another axiom of insurance engineering is that open- 
ings through the floors of a building should be closed. A 
fire causes an ascending draft of heated air, and flame 
naturally follows that course; furthermore, the natural 
draft in buildings is ordinarily upward. An open 
stairway or elevator shaft becomes at once a rapid and 
easy path for fire, often taking a fire from the basement 
into the comparatively inaccessible upper floors before 
the fire department can get fairly at work. With all 
such openings closed there is time to head it off. In 
constructing modern factory buildings this principle is 
observed by providing a brick tower or towers for stairs, 
elevators, and power transmission, with fire-doors at the 
entrances. 

The character of buildings is improving under the influ- 
ence of the bonus which insurance companies put upon 
good construction in the shape of low rates, but many are 
built in which the construction is so light that the benefits 
of cut-offs at floors can not be fully realized. The ques- 
tion of the saving in insurance which applies to the value 
of contents as well as to the building, and for the life of 
the building, is not given sufficient consideration in plan- 
ning. Many a building could have been far better built 
and would have been just as good an investment if the 
owner and architect had discussed the matter beforehand 
with a competent insurance engineer, as some of them 
always do. 

In addition to points of construction, the safe arrange- 
ment of the hazards of manufacture claims an important 
share of the engineer's efforts. Although the owner knows 
the processes of his business far better than any outsider, 
yet he frequently fails to realize the hazards of it. It is 
natural that in this respect he should not be as well able 



356 YALE READINGS IN INSURANCE 

to pass judgment as a man who sees those same hazards 
in a hundred other places also, and whose business it is 
to weigh them and safeguard against them. It is a 
noticeable fact that the owner usually optimistically 
believes that he has a better risk than most others and 
that his risk will not burn; an honest opinion which is the 
result of years of acquaintance with every nook and cor- 
ner of it, but which blinds him to the real dangers. As a 
rule, however, he is willing enough to consider such changes, 
accompanied as they are by convincing examples, and 
bringing with them a material reduction in the insur- 
ance premium. 

The cotton-mill presents a fine example of what the 
separation of the principal hazards can do for a type. 
At first there was no attempt to do this, and fires caused 
by the openers and lappers, which are the machines which 
tear the raw cotton apart and prepare it for carding, burned 
entire mills and consequently cotton-mills came to be 
considered as highly hazardous. Now, a modern cotton- 
mill is considered a good risk and when protected with 
automatic sprinklers, one of the very best of any sort, 
because, although these fires frequently occur, the machines 
which cause them are in a section of the building by them- 
selves, separated by two walls and two fire-doors from 
all other parts. Consider carefully the money significance 
of this arrangement. If the picker hazard were in the 
main mill, the entire insurance would be paid for at the 
high rate of that hazard, but cut off as it is now the high 
rate applies only to the value in the picker house. In a 
mill without sprinklers, suppose 15 per cent, of the insur- 
able value to be in the picker house, to which a rate of 
$1.50 applies and the other 85 per cent, to be in the mill 
on which the rate is 50 cents, then the separation of those 
hazards is saving the owner of that mill 85 cents per $100 
of insurance per year, indefinitely, or $1700 yearly on 
$200,000 insurance, an example not in the least exagger- 
ated of what this study of conditions by the insurance 



FIRE INSURANCE ENGINEERING 357 

engineer is doing for the owner every day, and any owner 
can obtain the judgment of a skilled man for the asking 
from a company which maintains one on its staff, with 
resulting benefits of the sort quoted, to say nothing of the 
added security which the improvement gives to his business. 

The study of processes with a view to separating the 
hazardous ones so that they can not endanger the other 
parts of the risk, and the reduction of the value in these 
hazardous places to the lowest possible amount so that 
the high rates will have the least effect upon the average 
rate, is of absorbing interest to the engineer and of direct 
benefit to the assured, and much ingenuity is displayed 
in the solution of such problems. Every industry and 
business is capable of profiting by this kind of an analysis, 
and it is the exception to find a property which has not 
had careful consideration on this basis, the rate of pre- 
mium on which can not be reduced by improvements at a 
cost that will be a good investment for the owner. In 
addition to the engineering information required, the spe- 
cialist in the employ of a company brings to a considera- 
tion of this sort a knowledge of insurance rules and 
contracts that is of value. 

As a result of work of this kind the companies now 
recognize that a modern risk of almost any sort can be so 
much improved that the history of risks of similar kind in 
the past is not a fair basis of judgment, and they consider 
risks on their individual merits. 

In the detection and safeguarding of hazards technical 
books and papers give very little information, except 
those written by insurance men, but there is an increasing 
number of these latter, which are put before the public 
from time to time and have good educational value. In- 
surance engineers are continually finding unsuspected 
hazards of new processes or new machines, which are 
consequently reduced or removed with the cooperation 
of the proprietors, which has already been of great benefit. 

It remains for the engineer to plan the most practical 



358 YALE READINGS IN INSURANCE 

means for fire protection after other considerations are 
finished, to the end that fires may be extinguished. This 
attention is not confined solely to the individual risks, 
but is bestowed upon the fire departments and the water 
supply and distribution of cities as well. For many years 
inspectors employed by insurance interests have regularly 
visited the cities and the larger towns, carefully examining 
fire departments and the conditions under which they 
work, making suggestions for the improvement of this 
service. For several years a more complete engineering 
organization has been in operation, under which a party 
of engineers, comprising experts in the subject of water 
supply, fire departments, and construction, visit a city 
together and stay there till they have carefully examined 
it, reporting upon the degree of exposure to conflagra- 
tion, and the ability of the water supply and fire depart- 
ment to cope with local conditions, including in the report 
the remedies which they deem advisable, with which the 
officials of the municipality are made acquainted. The 
protection of individual risks receives the equally careful 
consideration of other men in the employ of bureaus or 
companies. The best of advice is to be had for the ask- 
ing by municipality or private owner. 

Although fire insurance engineering has done and is 
doing much to prevent loss by fire in this country, some 
idea of how much there is to be done may be gained from 
a comparison with the low loss ratio in Europe where rates 
are so low that automatic sprinklers offer so little chance 
for further reduction that it is very hard to sell them. 
We quote a loss per capita of 12 cents in Italy, 49 cents 
in Germany, and an average loss per capita in Austria, 
Denmark, France, Germany, Italy, and Switzerland, of 
33 cents, as compared to a loss in the United States, in 
1908, of $3.02. 

There are several reasons for the low loss ratio, the 
principal one being the absence of wood in construction, 
and another the smaller number of fires. The first reason 



FIRE INSURANCE ENGINEERING 359 

is easy to understand, because except in Norway, Sweden, 
and Russia, the centuries of civilized occupancy have used 
up the timber so that within the life of present buildings 
it has been cheaper to build of stone, brick, tile, and other 
incombustible material. There is a very interesting 
consular report, printed in 1892 by the United States 
government, entitled "Fire and Building Regulations in 
Foreign Countries/ ' containing the answers to a set of 
questions on these subjects from consuls all over the 
world, that explains much. One may refer therein to the 
cities in the British Isles and on the Continent, except 
the countries already mentioned, and find that there are 
practically no wooden buildings and that such are forbid- 
den to be built, and this means that floors and staircases 
are incombustible as well as walls. The only use of wood 
that is noticeable is in the framing of the roofs in some 
localities. This plainly teaches us that in good construc- 
tion lies the greatest single safeguard against excessive loss 
by fire. Contrast San Francisco, a wooden city, simply 
wrenched by earthquake, half destroyed by fire, with Mes- 
sina, a city of masonry, leveled to the ground, but unburned. 

Certainly the fire protection of foreign cities is not the 
reason for their safety. In Rome, a city of 427,000 at 
that time, the department put out the fires with buckets 
and fire-extinguishers chiefly. They had hand engines 
for use where the water pressure was unusually low, and 
for cases of great emergency one steam fire-engine, but 
the last time it was used it was over two hours before 
it could be put into condition to draw water. Imagine 
Buffalo or Baltimore in that condition. 

There is one consolation in the impending depletion of 
our forests, that it may force the adoption of fire-proof 
construction, and so give back in saving from fire loss the 
amount lost in forest value. There are signs that the 
high price of timber and the difficulty of getting it have 
already started this movement. 

The other reason, fewer fires, is not so easy to under- 



360 YALE READINGS IN INSURANCE 

stand. Hartford, a city of about 100,000, had 300 still 
alarms and 147 bell alarms last year, representing actual 
fires. At the time of the consular report, Rouen, France, 
about the same size, had 29 fires in one year; Roubaix 
(114,000), the same; Rheims (105,000) 47, the average 
being less in Spain and Italy. London, 4,250,000 popula- 
tion, reported 2892 fires; the same ratio per capita as 
Hartford would have called for 14,500 fires. Porta Fayal, 
population 6790, a stone city, no fires for five years; 
Asuncion, Paraguay, 25,000 population, brick and stone 
buildings, no fire loss for seven years; Parimaribo, Dutch 
Guiana, 28,000 population, all buildings wooden, no 
serious fire for forty-five years, and only two alarms for 
seven years, each a small native hut. The almost uni- 
versal use of buildings of fire-proof materials no doubt 
accounts for some of the decrease in these foreign coun- 
tries, but there must be other stronger reasons, perhaps a 
slower pace, older civilization, the inherited instinct of cen- 
turies when fire insurance was non-existent and fire loss was 
irreparable, or a milder climate and less heating apparatus. 
Broadly speaking, the salvation of this country in respect 
of fire loss lies in the education of the public, beginning 
in an elementary way with the children, to which fire 
insurance engineering can contribute a highly important 
part. When the American people understand thoroughly 
that there are many lives and over $200,000,000 of money 
lost every year from this cause, surely the response will 
be effective and we shall ultimately cease to blush for the 
comparison with foreign countries. Although there has 
never been any attempt to make instruction of this sort a 
part of the education of the young until very recently, 
through insurance engineering the insurance companies 
are unreservedly giving the public the best advice to aid 
in decreasing this drain of men and material. May the 
time hasten when the people will realize their responsibil- 
ity and make free use of the benefits so freely offered, 
for the sake of the general welfare of the country. 



CHAPTER XX 

FERE PROTECTION WITH AUTOMATIC SPRINKLERS 1 

An automatic sprinkler is a water valve, held closed by 
the use of solder fusing at a low temperature, which is 
intended to open from the melting of the solder by the 
heat of a fire in order to distribute water as a fine spray 
to extinguish the fire. Similar devices have been known 
for many years, but no practical use was made of the prin- 
ciple until the early '80s, and most of the development has 
been in the last twenty years. 

Sprinklers are ordinarily installed eight to ten feet apart, 
in water pipes of graduated sizes from f inch to 6 inch 
diameter, attached to the ceilings at regular distances all 
through the buildings to be protected. The piping does 
not disfigure the rooms, being placed symmetrically with 
prominent parts of the framing. After a short time it 
ceases to attract the attention of those who know it is 
there, and the casual visitor seldom notices it at all, par- 
ticularly as the pipes are usually painted a color to corre- 
spond with their surroundings, although the sprinklers 
themselves should never be given any foreign coating. 

All manner of risks are equipped, including hotels, parts 
of dwellings, grain elevators, car barns, rolling mills, school- 
houses, and even a few steamboats, to mention some of the 
unusual sorts, as well as mills and factories, warehouses 
and stores of all kinds, even the most elaborately finished 
department stores. When the owner prefers to sacrifice 
accessibility to the ornamentation of the store, the pipes 

1 By Frederick C. Moore. 
361 



362 YALE READINGS IN INSURANCE 

are sometimes concealed behind the ceiling finish, only the 
sprinklers themselves projecting. 

In places which are freezing cold in winter, compressed 
air is maintained in the pipes, instead of water, by means 
of a "dry valve," which automatically allows water to 
enter when the compressed air escapes upon the opening 
of a sprinkler. Thus the system is maintained operative 
despite cold. 

The ordinary sprinkler opens at 155° or 160° F., but for 
places where the temperature is too high to use these, 
special sprinklers are made with solder fusing at 212°, 
286°, or 360° F., though the less necessity there is for the 
use of these the better, because they are slower to open. 

With the two methods just outlined, however, the ex- 
tremes of heat and cold commonly found can be met, so 
that it is feasible to have sprinkler protection in all parts 
of any risk. 

The business of installing sprinklers is almost entirely in 
the hands of the companies who manufacture them, as 
they will in most cases sell the sprinklers to only a few con- 
tractors who have long had dealings with them, an attitude 
based upon the belief that the work requires long experience 
to avoid errors which lead to expensive changes before the 
work finally complies with the insurance engineering rules, 
a doctrine that is quite in harmony with their business in- 
terests, and which is true for the average case of a property 
owner who expects his own mechanics to do the work well. 
These sprinkler companies will furnish detailed plans in 
advance to the insurance organization which is to pass 
judgment upon the work, so that the annoyance of sub- 
sequent changes is avoided by having the plan approved 
at the beginning. As the expense of forming and main- 
taining an organization that can make plans and estimates 
and do the work in accordance with the needs of insurance 
authorities and the property owners is high, and the in- 
vention of a sprinkler and the other necessary appurte- 
nances, which will meet insurance approval, is slow and 



AUTOMATIC SPRINKLERS 363 

difficult, there are few companies in the business, and it 
is exceedingly difficult for a new company to start. 

It is of great importance, particularly to the insurance 
companies, that any new sprinkler shall, before approval, 
be proven to be able to open when it ought, even under the 
disadvantage of slight corrosion or loading, and that it 
shall not open when it is not needed. To comply with 
both conditions is difficult, as the large number of sprinkler 
patents shows, and it requires about a year to make all the 
tests, which are all made by the same organization, and 
are, therefore, comparative. There are only seven differ- 
ent sprinklers in common use to-day. 

The customary preliminary procedure to obtain a sprin- 
kler equipment is to apply to the insurance organization, 
which passes judgment upon improvements for a plan and 
requirements to show what is necessary, in their judgment, 
to protect the risk. This information will be submitted 
in writing and will enable the owner to obtain from con- 
tractors the cost of the work. As he can also find out how 
much insurance will cost under the proposed conditions, a 
comparison of the cost with the saving can be accurately 
made, to govern the final decision whether to make the 
investment. It is highly desirable to advise fully the per- 
son who is to make the suggestions of any changes which 
may take place in the future, so that their influence on the 
equipment may be fairly considered, which will be well 
repaid by resulting economies when the necessary exten- 
sions to the protection come to be made. If the property 
owner possesses the necessary information, or can have 
expert advice, it is an excellent plan to draw up a plan 
and requirements which can be considered in detail from 
every point of view at leisure, the perfected result to be 
submitted to the insurance organization whose approval he 
desires, which has the merit of enabling the owner to meet 
the representative of that organization with an appreciation 
of the matter that will enable him to discuss fully and 
definitely, ensuring complete understanding on both sides. 



364 YALE READINGS IN INSURANCE 

It is natural to ask what benefits are given by automatic 
sprinklers? The most important one is the protection to 
an established industry by decreasing to the utmost the 
chance of its being swept out of existence by an internal 
fire, which is insurance of prosperity. The product of such 
a plant is worth more to a buyer who is depending on it 
than that of an unprotected factory. Another is the 
ability to obtain insurance indemnity to cover fully risks 
of very large value, which would be impossible without 
sprinkler protection, upon which insurance companies rely 
to protect them in the assumption of much greater than 
ordinary liability; similarly, a risk of even moderate value, 
which, nevertheless, can not obtain full insurance because 
physical disadvantages are too heavy, may be so adequately 
protected by this means that insurance is readily procured. 

A complete equipment usually includes hydrants and 
hose, and various other appliances besides sprinklers, often 
the protection of important door, window, and floor open- 
ings, and sometimes the modification of other physical 
conditions, because a survey for laying out sprinkler pro- 
tection considers the improvement of the risk as a whole, 
to the greatest degree consistent with the governing con- 
ditions, for at the low rates under which such protected 
risks are written, not only must the protection be per- 
fected, but the chance of occurrence of fire must be de- 
creased, and its opportunity to spread, limited. The cost 
of sprinkler protection is therefore increased by these other 
improvements, and the whole varies so much that no set 
rule is reliable, but it is not uncommon to save enough on 
the insurance premium by reduction in rate, to offset the 
cost in four or five years, which is excellent interest on the 
investment, and a better showing may be made under 
specially favorable circumstances. Considering only the 
automatic sprinkler system inside the building to the point 
where the supply mains enter, not including any work on 
the water supplies, a roughly approximate idea of cost 
may be obtained, by estimating the number of sprinklers 



AUTOMATIC SPRINKLERS 365 

required on the basis of 80 square feet of floor space per 
sprinkler, and multiplying the number of sprinklers by 
$3.50. Special conditions will vary the cost considerably, 
and to the cost for the sprinkler system is always to be 
added that of the water supplies and other improvements. 
An ordinary risk will expend $3000 to $5000, and large 
ones ten times as much. 

The cost is not directly proportionate to the insurable 
value and there are certain essentials for any risk, however 
small, so that it ordinarily does not pay to equip risks of 
small value and there are comparatively few equipped 
carrying less than $40,000 insurance. The average amount 
of insurance per risk for 126 risks thus equipped was 
$251,182. 

The important reason why automatic sprinkler protec- 
tion successfully controls fires is because it is automatic. 
The instant heat opens a sprinkler, water issues on the fire, 
day or night, work days or holidays, summer or winter, 
provided conditions are not abnormal. The result is 
shown by the record of 8942 fires, reported in risks equipped 
with sprinklers during a period of more than twelve years, 
of which 5791 were extinguished by sprinklers unaided, 
in only 483 cases did sprinklers prove practically useless, 
and in the other fires other apparatus was also used. In 
7239 cases, 83 per cent., not more than twelve sprinklers 
opened, which shows the value of applying the water at 
the very outbreak of fire. A single sprinkler at 30 pounds 
per square inch will discharge as a fine spray about thirty 
gallons a minute. Under most conditions the operation 
of one or two sprinklers would have 30 pounds pressure. 
At 100 pounds the impression is created in the mind of 
an observer that the spray is so dense and forcible that 
a man directly under the sprinkler would strangle. 

Notwithstanding the copious discharge under adequate 
pressure, it is always necessary to exercise great care to 
prevent conditions which will cause fire to open many 
sprinklers. The water supply is not sufficient in most cases 



366 YALE READINGS IN INSURANCE 

to remain effective when the loss of pressure by friction, 
which very heavy draft occasions, cuts the pressure at 
the sprinklers down below the 2.5 pounds during opera- 
tion, which is admitted as the minimum allowable. Because 
of this possibility the general belief is that sprinkler pro- 
tection is principally dependable when fires do not gain 
headway enough to open very many sprinklers, and this is 
a safe and reasonably true doctrine. When the water 
supply is very strong, sprinklers will stop a heavy fire 
which opens many heads. 

There are conditions which prevent sprinklers from giving 
the protection expected, even when properly installed, and 
their favorable record is at the cost of continual inspection 
with the cooperation of the owner. In places where cor- 
rosive vapors are given off by the processes, such as dye- 
houses, bleacheries, dry rooms, chemical works, and many 
others, considerable numbers of the heads become so cor- 
roded that they will not open as they should, and this is 
apt to be the case after a longer time, even with those 
which have been specially treated by the maker with a 
protective coating. Their condition can not be reliably 
gauged from their appearance, but must be determined 
by an expert test of a representative number of those sus- 
pected, such as can be obtained with the aid of the insurance 
authorities. It is a serious condition, absolutely putting 
the sprinklers out of commission, and to be remedied only 
by replacing the sprinklers as often as necessary. 

From carelessness or ignorance, sprinklers frequently 
become coated with paint, whitewash (particularly from 
spraying machines), bronze or silver gilt, encrustations of 
soap, sugar, cement, plaster, or other materials, which 
are very apt to be similarly objectionable. 

Another trouble is that frequently an employee of the 
property owner disconnects or shuts off parts of the system 
on account of repairs to building or machinery, forgetting 
to put the sprinklers back into service as soon as possible. 
It is a too frequent occurrence, and leads to the removal 



AUTOMATIC SPRINKLERS 367 

of sprinkler protection from sections of a few heads to the 
systems of entire buildings. The same owner would re- 
quire to be told if steam were shut off from the engine five 
minutes, and he ought to be just as particular about the 
water for the sprinklers. Similar in effect is the erection 
of additions, mezzanine floors, racks hung from the ceiling, 
partitions, or any structures which form unprotected 
sheltered spaces in or adjoining a building equipped with 
sprinklers, and the system should be promply extended to 
cover them. 

Enough has been said of the commoner causes of poor 
sprinkler service to emphasize the important principle that 
the owner should devote care and attention to the sprinkler 
system, as he would to any part of his machinery of pro- 
duction, and the greatest aid to such proper supervision 
is an inspection by some specially delegated employee at 
regular, frequent intervals, riling a written report. Nearly 
one-half of the sprinkler failures on record are due in about 
equal numbers to water being shut off or to defective or 
partial equipment, the first entirely preventable, and the 
second to be much reduced when acquaintance with the 
matter teaches the owner that a sprinkler system, as well 
as his machinery, has its limitations. 

With some conditions a sprinkler equipment can not 
be expected to cope. It will be overwhelmed by confla- 
gration, long continued exposure from without, which 
very likely cuts down the pressure of its water supply by 
heavy draft of fire department. It is apt to be disabled 
partly or wholly at the start in a risk where the processes 
give rise to explosion. In hollow walled, hollow ceiled 
buildings it can not extinguish fire in the hollow spaces. 
In industries using large amounts of inflammable liquids, 
particularly those lighter than water, or large piles of 
articles which shed water, like barrels, lumber, furniture, 
— it will not extinguish the first or reach the fire in the 
others. 

The life of a sprinkler system put in according to present 



368 YALE READINGS IN INSURANCE 

rules ought to be at least thirty years, under average con- 
ditions and probably longer. Pipe put in twenty-five 
years ago is as good as ever, but it was wrought-iron pipe, 
while soft steel pipe is used now. The sprinklers them- 
selves have given no proof that they deteriorate with 
mere age, if properly designed in the first place. From 
the point of view of cost of maintenance the present per- 
fection of the methods of designing and installing fire 
protection is a more important matter than the life of 
the system, for it practically guarantees that it will be 
unnecessary during its lifetime to rebuild a system be- 
cause it is not adequate for the work it was supposed 
to do. Many of the early systems did not get a chance 
to wear out, because experience showed they were not 
dependable and they were remodeled. 

Factories and mills constitute the larger number of 
risks equipped, many of them isolated. To-day the equip- 
ment of risks in the congested areas of cities is becoming 
much more frequent, which is an excellent thing to de- 
crease the chances for conflagration by diminishing the 
number of risks in which serious fires may occur, because 
such risks are usually large and therefore troublesome to 
control if they burn. The growth of automatic sprinkler 
protection is due to the unquestionable fact that it is the 
best known method of extinguishing fires inside a building. 



CHAPTER XXI 

FACTORY MUTUAL FERE INSURANCE 1 

The system of factory mutual insurance was established 
by the late Zachariah Allen, of Providence, Rhode Island, 
in the year 1835, when he and his associates organized 
the Providence Manufacturers' Mutual Fire Insurance Com- 
pany. In 1848 the Rhode Island Mutual Fire Insurance 
Company was established. 

On January 1, 1900, the Boston Manufacturers' Mutual 
Fire Insurance Company 2 entered upon the fiftieth year 
of its existence. The first policies issued were dated 
September 14, 1850. In that and in the ensuing year, 
1851, one hundred and eighty original policies were issued 
to one hundred and ten members in the sum of $3,320,560. 
The cash premium or deposit subject to losses and expenses 
amounted to $33,320. The maximum hazard taken on a 
single risk was $30,000. The rates varied from a mini- 
mum of 40 cents on some storehouses to 1J per cent, on 
certain mills. These rates had been established by the 
two older Providence mutual companies, the Manufac- 
turers' Mutual and the Rhode Island Mutual. I am in- 
formed that the mutual rates were made on the basis of 
the schedule of some of the older stock fire insurance com- 
panies, at three-quarters the charge made by the stock 
companies on the same property. 

It is evident that the members and directors rested 
upon the power of assessment more than upon the cash 

1 By Edward Atkinson. Reprinted from " The Prevention of Loss 
by Fire " ; Damrell and Upham. Boston, 1900. 

2 The present chapter deals particularly with the experience of this 
company. 

369 



370 YALE READINGS IN INSURANCE 

payment in the early history of this, and other factory 
mutual companies, yet, since 1850, there has been no 
assessment required by this or any other of the associated 
factory mutual companies. 

During the earlier period of their history the picker 
departments of cotton and woolen factories were not 
insured by the mutual companies, nor can I find any evi- 
dence that they were separately insured. The risk was 
probably carried by the owners. It was deemed excess- 
ive. But immediate measures were taken for protecting 
pickers in much greater measure than for the protection 
of mills, and from computations which I have recently 
made of the proportions of loss in ratio to value of picker 
buildings and contents, as compared to the main mills 
and contents, the loss relatively has been less than in the 
works proper; thus proving again the one rule developed 
in this work, a rule which must be fully comprehended 
outside the lines of the factory mutual companies if the 
terrible losses by fire in the United States are to be reduced. 
The rule is as follows: 

After the insurance company has done its duty by care- 
ful selection of risks and thorough inspection, all that it 
can do is to pay indemnity for loss which, if large, is in 
nine cases out of ten due either to the lack of apparatus 
for preventing such loss, or to lack of care and order in 
the conduct of the work. The only persons who can pre- 
vent loss by fire are the owners or occupants of the insured 
premises. Upon them rests the responsibility for heavy 
loss, when any occurs, in nearly every fire. 

It has always been the practice of the mutual companies 
and of late, with excellent results, the practice of the stock 
insurance companies, to instruct owners and occupants 
upon their duties to their own property, and to keep them 
up to the mark by constant supervision and by refusing 
to grant contracts of indemnity to those who neglect their 
own duty. 

The most difficult work of the president of a mutual 



FACTORY MUTUAL FIRE INSURANCE 371 

fire insurance company is to do away with the antag- 
onism of owners against the underwriters, and to secure 
that cooperation in preventing loss by fire which ensues 
as soon as the identity of the interest of the owner and the 
underwriter is established. 

In 1850, when the Boston Manufacturers' Mutual Fire 
Insurance Company was organized, the Manufacturers' 
Mutual Fire Insurance Company, of Providence, Rhode 
Island, had been in operation for fifteen years; the Rhode 
Island Mutual Fire Insurance Company for three years. 
Each of the above-named companies issued policies not 
exceeding $15,000 on a single risk. This company began 
by issuing policies not exceeding $30,000 on a single risk. 

The Firemen's Mutual Fire Insurance Company was 
organized in 1854, the Worcester Manufacturers' Mutual 
in 1855, the State Mutual, of Providence, in 1858, and the 
Arkwright, of Boston, in 1860. Several years elapsed 
before any other mutual companies were organized. 

The losses have never been so great in any one year as to 
subject either one of these companies to the necessity of 
making an assessment in addition to the sum deposited 
at the beginning of each term, during this period of fifty 
years. Had this property been of necessity insured in 
any other way than by the factory mutual companies, 
there would have been two periods, one immediately 
after the Chicago fire and one immediately after the Bos- 
ton fire, when a large part of the contracts of indemnity 
which had been paid for would have become worthless. 
That danger of great city conflagrations still exists. 

The secret of this success is to be found in the fact that 
when men combine with each other for mutual insurance 
they very soon learn the one lesson, which I repeat: 

The only persons who can prevent loss by fire are the 
owners or occupants of the insured premises. Upon them 
rests the responsibility for heavy loss, if any occurs, in 
nearly every fire. All that the insurance company can 
do is to pay indemnity for loss, which, if large, in nine 



372 YALE READINGS IN INSURANCE 

cases out of ten is due to the lack of apparatus for prevent- 
ing loss or to lack of care and order in the conduct of the 
work. 

At later dates eight other factory mutual companies 
have been organized in Massachusetts and Rhode Island, 
and are now associated with the ten senior companies for 
the joint inspection of risks, but as they came in after 
the greater part of all the older risks had been covered 
by the senior companies, they extended their service over 
such large concerns as could not be wholly covered by the 
senior companies and over other classes in a wider area, 
in which service they have rendered a proportionate bene- 
fit to their members; their earlier dividends exceeding 
those of the senior companies in their early history; their 
recent dividends exceeding those of the senior companies 
down to and including 1879, when great changes were 
made in the general conduct of the system as will be here- 
after stated. 

In 1878 the revenue of this company from premiums 
was $366,000 — the maximum hazard on a single risk, 
$80,000. The liability to assessment was still created by 
the execution of notes promising to pay five times the 
cash premium in any emergency. The giving of these 
notes was often objected to, and was in fact superfluous. 
Measures were presently taken for a change of the law by 
which the acceptance of the policy created the liability, 
but it was evident to the undersigned that the cash receipts 
ought to be brought to so large a ratio to the maximum 
hazard taken on a single risk, as to render resort to assess- 
ment so remote a contingency as to be disregarded sub- 
stantially, and to that status the present condition of the 
company has been brought. 

Before 1878 no customary or regular meetings of the 
directors had been held. Inspections had been made 
in a desultory manner by the presidents or secretaries 
of the several companies about once a year, usually a few 
weeks before the expiration of the policy. Modern safe- 



FACTORY MUTUAL FIRE INSURANCE 373 

guards had not been thoroughly investigated. Auto- 
matic sprinklers were known, but had secured little or no 
attention. There were no experience tables, no classifi- 
cation of risks, and no real comprehension of the relative 
hazard on different classes. Everything depended on 
the personal knowledge and the extraordinary memories 
of Messrs. Manton and Whiting. Losses had been subject 
to great variation year by year, as will appear from the 
diagrams submitted with each annual report. It had 
become manifest to myself and other directors that a very 
complete change must be made in the conduct of the whole 
system, and that new safeguards must be found in order 
to meet the increasing hazard of larger floor areas, mills 
of many stories in height, higher speed, new dyestuffs, and 
to anticipate the new hazard of mineral oil, then gradually 
being introduced as a lubricant, of electricity, etc. 

There also existed a feeling among many members 
such as governs ordinary business, "not to put too many 
eggs in one basket." Those who did not investigate the 
subject were governed in the distribution of their insurance 
by the amount of the policy, and not by the proportion of 
the policy to the revenue of each company. It did not 
occur to them, and it does not now occur to many others, 
especially to applicants, that if the annual income from 
premiums is three to four times the maximum hazard taken 
on any single risk, it is as safe for the member to take, 
and for the insurance company to grant, a policy, say of 
$200,000 on an income of $900,000, as it would be to grant 
a policy of $20,000 on an income of $90,000. On the other 
hand, by such a concentration, the relative expenses of 
conducting the several companies are greatly diminished. 

In 1878 the first duty of the president was to eliminate 
poor risks; the amount of insurance written was $43,000,000. 
In that year and the next a large amount of insurance was 
canceled which could not be brought to a proper standard 
of safety, but new risks were added, so that in 1879 the 
amount written was $44,500,000. 



374 YALE READINGS IN INSURANCE 

Measures were taken to establish a quarterly inspection 
under the supervision of Mr. William B. Whiting, the 
secretary of this company. A regular system was organ- 
ized, the accounts being kept on the books of the Boston 
company, the charges being shared in proportion to the 
relative service by all the senior companies and a portion 
of the junior companies. At a later date an association 
was formed to conduct the system of joint inspection at 
the joint expense of all the companies, since which date 
the accounts have been kept upon a separate set of books. 
The executive officers now meet in monthly conference. 

In 1880 what may be called the science of preventing 
loss by fire was fairly entered upon, and at that date 
measures were taken, after careful consultation with the 
very few manufacturers, who at their own motion put in 
the automatic sprinklers, for the extension of that ser- 
vice, which has now become practically universal. With- 
out their support and the confidence due to their practical 
experience, the writer would have had much more diffi- 
culty in promoting the adoption of sprinklers, as some of 
his own insurance associates were skeptical, and two were 
positively opposed to them. But the writer had become 
convinced that, unless the hazard of larger and larger 
factories, higher speed, etc., could be met, the mutual 
system would break down; and he then told his associates 
that automatic sprinklers must be made a condition, cost 
what it might. In ten years more than half the work 
was done; in twenty years it has been completed. 

In 1879 a careful compilation was also begun, by which 
the combined experience of all the mutual companies 
could be registered year by year. In this company risks 
were divided into ten classes; losses were sorted in propor- 
tion to risk taken and premium received from the beginning 
of the company to that date. A very wide variation 
from the average was disclosed. On one class the loss 
had been over 60 per cent, of the premium received; on 
another it had been but 10 per cent. Measures were 



FACTORY MUTUAL FIRE INSURANCE 375 

taken for the more complete protection of the risks in 
which the heavy losses had been disclosed and rates were 
raised. On other risks slight concessions in rate were 
made, but since the number of hazards in each class, 
with the exception of three, did not suffice to establish a 
rule, one loss of considerable amount throwing the average 
out for a number of years, time was allowed to elapse to 
justify further changes, if any were required. 

Various changes have been made in the adjustment of 
rates, the inclusion of new risks and the exclusion of poor 
risks, so that the average loss of premium received on each 
class has been brought to as close an approach to uniform- 
ity as it is probable can ever be attained. We are occa- 
sionally liable to a large loss in a class in which there is a 
small number of risks, which of necessity throws the average 
out for a considerable period of time. The compila- 
tion of statistics is very necessary as a guide to the judg- 
ment of the underwriter, but the president, especially 
the mutual underwriter, who should undertake to govern 
the conduct of the work by giving regard only to the 
statistics would either fail, or would be subject to a very 
wide variation from any equitable adjustment of the rela- 
tions of each member to the other. 

There have been variations in the judgment of the differ- 
ent boards of directors in the several companies. To 
some the so-called conflagration hazard has given fear of 
an assessment; but both the statistics and the observa- 
tion of others disclose the fact that in the great factory 
cities, where what are called the single hazards are so 
near to each other as to suggest the danger of an exten- 
sion of the fire by conflagration, the additional safeguards 
in the supply of water and the aid which one mill can 
render to another have resulted in a considerably less pro- 
portion of loss, either to risk taken or premium received, 
than is disclosed by the figures of the isolated mills. 

No fire in any one of the large factory cities has yet 
extended in a destructive manner from one risk, deemed a 



376 YALE READINGS IN INSURANCE 

separate hazard to another, either in the same yard or in 
an adjoining mill yard. There have been but five fires 
which have extended from the building, or separate risk 
in which the fire originated, to another building covered 
by our insurance, to such a degree as to cause a consider- 
able damage in the second building. These fires have 
occurred in what are called our isolated risks. 

There has recently been a fire which passed from one 
auxiliary building into another in the same yard without 
substantially doing injury to the main mill, starting in 
an unsprinkled section (now sprinkled), and extending 
for want of skill in the use of the fire apparatus; but these 
two buildings were not considered separate risks accord- 
ing to the construction of that term. 

The mutual contract cannot be safely adopted in the 
crowded districts of cities, for the reason that the owner 
or occupant of one building may have a very dangerous 
neighbor in the next, over whom he has no control; he 
may not therefore expect to reduce the cost of insurance 
to the lowest standard attained under more favorable 
conditions. 

During the fifty years of the existence of this company 
there has been no instance of fire intentionally set by the 
owner or occupant for the purpose of getting money. 
There has been but one suspicion of such fire, which after 
some years was disproved by the confession of the incen- 
diary who had no interest in the property. There has 
been but one resort to litigation. That was in the case 
of the Pemberton mill, which owing to a defect in a cast- 
iron post fell down, taking fire after the fall. The ques- 
tion was raised by the underwriters whether this was an 
alteration in the risk not contemplated by the contract, 
due to the neglect of the owner. So far as I can learn, 
the case was submitted to arbitration, and was compro- 
mised by the payment of a sum of money, corresponding 
to the value of the property after the fall and before the 
fire. What proportion this came to I am unable to say. 



FACTORY MUTUAL FIRE INSURANCE 377 

I repeat once more, distrust has sometimes been caused 
by misapprehension or misrepresentation in regard to the 
risks taken in the large factory cities, of which there are 
six, in which many mills insured separately are on the same 
lines of canal and are sometimes held to be subject to a 
conflagration hazard. The experience of fifty years proves 
conclusively that the benefit and additional security due 
to this proximity is much greater than the danger of a fire 
extending from one mill to another. There has been no 
such incident. On the other hand, bad fires have occurred 
in the heart of these cities, with high winds blowing and 
under conditions which, had they been the ordinary mer- 
cantile risks of a city, might have caused an extensive 
conflagration; but the aid which each mill extends to the 
other and the enormous flood of water that can be poured 
upon any single fire from roof hydrants and other vantage 
points has enabled the well-organized mill fire depart- 
ments, working in cooperation with the city fire depart- 
ments, to put out all such fires without any destructive 
extension from the building in which they originated. I 
again call attention to this fact because the same precau- 
tions and safeguards could be adopted for the protection 
of city warehouses and blocks, and until they are, the appal- 
ling danger of great conflagrations will continue. 

One or two other incidents may be named. It was 
formerly the practice to appoint outside adjusters as well 
as to compromise on an appraisement; both practices are 
now ended. Losses are now adjusted by representatives 
of the owners and of the underwriters as nearly according 
to the facts as it is possible to appraise them. There has 
been no difficulty in carrying out this plan to the satis- 
faction of all parties in interest. 

It may be added that, in four instances, losses have 
been settled to the satisfaction of both parties, when 
subsequent adjustments or events disclosed the fact that 
very considerable omissions had been made by the owners 
in submitting their statement of property damaged, one 



378 YALE READINGS IN INSURANCE 

mistake being discovered many months after the adjust- 
ment. In these cases the owners have been requested 
to submit their additional claims, and the amounts have 
been paid, the intention of the mutual companies being 
to pay, in every instance, the exact measure of indemnity 
that may be justly due. In another recent instance a 
loss had been settled by the principal owner, the treasurer 
being away for his health, on the assumption that the 
goods stored had been taken in the inventory of a few 
days before at market value. Two months later, on 
advices from the treasurer, it appeared that these goods 
had been valued at 20 per cent, less than market value. 
The case was re-opened and the difference cheerfully 
paid. 

In only two or three instances that the writer can re- 
member has there appeared to be any effort made on the 
part of the assured to claim more than a just measure of 
indemnity under such conditions as to disclose an intent 
to get more than the true amount. These adjustments 
have then been made according to the facts; but on the 
expiration of the policies, the representatives have been 
informed that they could not remain members of the mutual 
companies. 

The general conclusions to which the writer has been 
led are, that it is necessary for the conduct of mutual 
insurance to be as well assured of the quality of the man- 
agement and the men in charge as of the risk itself. Al- 
though this discrimination has formed a constant part of 
the duties of the executive officers, we have reached a 
general conclusion that there is much less loss from fires 
intentionally set in order to collect the insurance money 
or from incendiarism, than is commonly imputed to these 
causes. I am also well satisfied that when losses that 
have occurred are taken up by the underwriters with the 
intention of paying a just measure of indemnity, any effort 
on the part of the assured to secure a larger payment is 
uncommon. 



FACTORY MUTUAL FIRE INSURANCE 379 

I think it never occurred to the founders of the mutual 
system and I am sure that it had not occured to myself, 
that we were engaged in developing an applied science, 
not only of the utmost importance to the economy and 
safety in the factory system, but which may slowly be of 
great service in putting a stop to the destructive fire tax 
of the country. It may therefore be useful to put upon 
record the gradual growth of our work until its true scope 
was almost forced upon our minds in the process of work- 
ing it out. 

Careful records had been kept by the late William B. 
Whiting, of the incidents of each fire which had occurred 
during his official connection with the company for nearly 
the whole of the first thirty years, and I was enabled to 
recover some accounts of the few fires of any importance 
that had occurred before his time. These fires and their 
causes were tabulated. 

The first fact which was disclosed was the large number 
of fires and the large amount of losses attributed to broken 
lanterns. This led to an examination of all the lanterns 
in mill use, then wholly supplied with animal oils. Not a 
single safe lantern could be found in use. All were badly 
made, liable to melt at the joints and insufficiently guarded. 
On searching for good lanterns none could be found except 
expensive brass lanterns made for the railway service. 
Warnings were given, due precautions taken, and, in con- 
nection with the firm, now called the F. 0. Dewey Company, 
safe lanterns at moderate cost were invented, but it took 
five years to perfect this apparently simple device. Many 
improvements have been made and there are now two or 
three types of safe and suitable lanterns for mill use, 
burning either animal oil, mixed oils, or mineral oils. 
Since that study of the lantern question there has not 
been a loss of any considerable amount in any of the works 
insured by this company which could be reasonably attrib- 
uted to fault in the lantern. Careful attention to lanterns 
would doubtless save many fires and losses in city risks, 



380 YALE READINGS IN INSURANCE 

but what owner or occupant ever gives his personal atten- 
tion to this insignificant cause of very heavy losses? 

The second great cause of fires was found in the various 
oils in use both for lubrication and for smearing wool. 
The mineral oils were largely used for lubrication; mixed 
oils were also used, but in the finest work, especially in 
weaving, fine sperm oil was still assumed to be the only 
suitable oil. In smearing wool, olive oil, lard oil and mix- 
tures under fancy names more or less liable to spontaneous 
combustion were in use. 

The spontaneous combustion of waste had previously 
been one of the principal causes of loss by fire. This 
danger has been almost wholly removed from cotton 
factories by the substitution of the mineral or so-called 
paraffine oils for lubrication, in place of animal oils, the 
mineral oils having no affinity for oxygen. Our investi- 
gation of oil disclosed the fact that 33 per cent, of mineral 
oil, mixed with lard oil, would overcome the tendency to 
spontaneous combustion. But these mixtures do not serve 
in machine tool work. Therefore, there is still a liability 
to the spontaneous combustion of waste used in wiping 
tools in the repair shops of the textile factories, where 
pure lard oil must still be used on the cutting tools, also 
in all our machine and metal-working risks. The liability 
to spontaneous combustion in woolen mills has been very 
much reduced since methods were discovered for scouring 
wool, treated with mixed oils, partly consisting of the 
mineral oils. 

Another singular cause of loss was the pitched roof of 
factories, commonly called the barn roof. When this 
roof was substituted for the old style factory roof, the 
practice was common to put vertical sheathing a few feet 
from the joining of the roof with the floor, making a 
long hollow space behind the ceiling at the eaves. This 
was at the time when nothing but animal oils were used 
for lubrication, when waste was therefore liable to spon- 
taneous combustion. Several roofs were burned. At 



FACTORY MUTUAL FIRE INSURANCE 381 

length one-half of the roof of a mill was burned, the fire 
being stopped by the tower. It then occurred to some 
one to investigate the conditions of the unburned part, 
and behind the sheathing were found large numbers of 
rats' nests made of oily waste. The cause of the fire 
then became plain, — the spontaneous combustion of 
rats' nests. When this fault was discovered all these 
sheathings were removed, and the space was kept open 
over the whole area of the attic floor. That barn roof 
is no longer tolerated. 

Many destructive fires had originated from hot bearings, 
especially on main shafts. The first fire which called 
attention to this cause occurred in a basement weaving 
room two hundred feet long, from a hot bearing at one 
end of the room. The fire jumped from loom to loom, 
passing many, melting the solder of a gas meter at the 
further end, without scorching a towel hanging closely 
underneath. This led to a suspicion of evaporation, 
it being assumed that the heavy hydrocarbon vapors 
had been kept in flakes or planes in the atmosphere by the 
motion of the looms. On examining the oil, it proved to 
evaporate 24 per cent, in ten hours at a heat of 140°; 
that being a heat not infrequently attained on a heavy 
bearing. Samples were called for from various mills. A 
tabulation was made of nearly one hundred cotton-mills, 
which proved a very great variation in the cost of oil to a 
pound of cloth in the quantity of oil used for lubrication, 
and in the prices paid for the oils. 

In fifty-five mills on print cloth numbers, among which 
there was no good reason for any variation in the cost of 
lubrication, the average price paid for oil varied from 
29 cents per gallon to $1.05. The gallons of oil to a thou- 
sand pounds of cloth varied from 1.3 to 2.84. The cost 
of oil per thousand pounds of cloth varied from 68 cents 
to $2.58. There was no apparent relation of price, quan- 
tity, or cost each to the other. This table was printed 
without giving the names of the mills, and submitted to 



382 YALE READINGS IN INSURANCE 

all the contributors, each with a key to his own number. 
The conclusion reached by all was that each knew little 
about the subject, while the rest knew less, and I concluded 
for myself that I knew nothing, and that it was time to 
bring lubrication to a science if it were possible. This 
was fairly accomplished. The mineral lubricating oils are 
now made of various qualities more or less fluid and more 
or less filtered, but the prices range from a minimum of 
13 cents to a maximum of 30 cents for such oils as are 
made use of on ordinary cotton machinery. What the 
relative quantity used in recent years is I have no means 
of ascertaining. 

The investigation was followed up until it proved that 
there was but one well-distilled and safe mineral oil for 
lubrication to be found, that being made under a patent. 
In all the rest grave faults were discovered, mainly, that 
of rapid evaporation. Notice was immediately given to 
the makers of these oils that a warning would be published 
to all our members not to buy them or to use them under 
any circumstances. This led to a threat of a suit at law 
for interfering with their business, which I immediately 
urged them to enter in court, as I desired to publish the 
facts; but I advised them to settle the patent rights and 
to change their methods of distillation, which advice was 
taken. A year later, wishing to secure some of the vola- 
tile oil for experimental purposes none could be found in 
the market. The price and cost of lubricating oil were 
very greatly reduced, all oils being brought to a uniform 
standard; very great benefit in money and increased safety 
have since ensued. From the conclusion of that investi- 
gation to the present time serious losses from hot bearings 
have been very rare; in fact, there is not one of any 
moment on our record that I can recall. 

Several members reported to me that their saving in 
the cost of lubricants in the next two years, resulting from 
this study, had been more than the cost of their insurance 
in the same period. 



FACTORY MUTUAL FIRE INSURANCE 383 

A warning was also given on the reckless use of very 
combustible varnishes on wooden surfaces, over which 
fire will pass with the speed of a race-horse, and may be 
ignited by the slightest cause. Care should also be 
given to the quality of the materials which are used in 
treating the surfaces of unpainted wood in offices and 
dwelling houses, which are apt to be rubbed down with 
rags impregnated with very dangerous materials of which 
linseed oil is almost sure to be one of the ingredients. 
Two instances have occurred in dwellings of my personal 
friends where these rags, put away in the pantry drawers, 
have set the house on fire. 

After testing and rejecting every existing kind of appa- 
ratus for ascertaining the coefficient of friction, an instru- 
ment was invented by Professor Ordway on which exact 
results were secured. That was afterward improved in 
some measure, and is now in the laboratory of the 
Institute of Technology. We may claim that lubri- 
cation has become an applied science from this investiga- 
tion. 

Methods of lighting were taken up at a very early date. 
Illuminating gas was mainly in use. There had been 
very serious fires and heavy losses, coupled with the loss 
of life, from the breaking of gas pipes during fires, throw- 
ing large volumes into burning buildings. Attention was 
immediately given to outside gates or valves and to right 
methods of cutting off the gas at the outbreak of a fire, 
which were wholly wanting in many cases. 

At one period there were upon our books one hundred 
and fifty risks or more lighted by kerosene oil lamps. 
There had never been any considerable loss from this 
cause, except from bad lanterns, although many of the 
lamps were unsuitable. Measures were taken to substi- 
tute safe lamps and burners for the poor ones. Atten- 
tion was given to the quality of the oil in use and the very 
cheap and dangerous tubular lanterns were thrown out, 
safe ones being substituted. The number of mills lighted 



384 YALE READINGS IN INSURANCE 

in this way is now much reduced, electric lighting having 
been substituted. But from that time to the present there 
has been no considerable loss of any kind from this cause, 
and only one loss, slightly exceeding one thousand dollars, 
which could be attributed to the use of kerosene oil; that 
was caused by the breaking of a bad lantern brought into 
the yard from the outside by a workman without the 
knowledge of the agent. 

The next subject investigated was the fire-door. The 
record showed that iron doors had failed; one of the heavi- 
est losses previously on record having happened from the 
warping of the iron fire-door which separated the picker 
department from the main mill, the fire passing, and the 
mill being destroyed. Efforts had been made to intro- 
duce the tin-clad wooden door, but it was often badly 
made for want of proper instructions. The sliding door 
had been put in position by Mr. Byron Weston. The 
writer invented an automatic method of closing doors, 
shutters, and hatches in rather a clumsy way, since very 
much improved; he fortunately used a lever released by 
the melting of fusible solder in that undertaking and in 
the construction of a valve for the conversion of a per- 
forated pipe into an automatic sprinkling system. 

The next subject taken up was fire hose. The practice 
of the makers of unsafe hose was to recommend to the 
owners to hang up cheap hose "in order to satisfy the 
insurance inspectors." Much of it proved worthless. A 
thorough investigation was made, and information was 
given to all members as to whom they could trust in the 
purchase of hose. This work has been subsequently ex- 
tended by the establishment of types of hose designated 
as the "underwriter" hose, which can be readily identi- 
fied. But incautious persons are still apt to be cheated 
on low-priced hose offered them at less than any possible 
cost for hose of a suitable kind. How many owners or 
occupants of city buildings ever give any attention to 
their fire hose, except to see that there is enough cheap 



FACTORY MUTUAL FIRE INSURANCE 385 

hose hung up "to satisfy the inspectors of the insurance 
companies"? 

The general question of the proper height and the 
right construction of factory buildings received very early 
attention. There were then several examples of the eight 
or nine-story factory building surmounted by the early 
type of the so-called factory roof; the roof itself, in some 
instances, being two stories in height. One large risk in 
part under these conditions was dropped as soon as cir- 
cumstances would permit; the worst building, a large one, 
having soon after burned. In another instance the owners 
were induced to remove the two-story roof and to put on 
timber and plank at the level of the sixth story, making 
place for the machinery previously in the upper stories 
on the ground. After the work had been done it was 
justified, not only by increased safety but by the greater 
economy in the work of the factory. 

Many other risks were covered in by the pitched or 
barn roof, slated — a very bad type. Later came one 
of the worst inventions in combustible architecture, the 
so-called Mansard, or French roof. By persistent action 
we have secured the removal of many of these roofs, with 
great benefit to owners in the conduct of manufacturing 
and very much greater safety. 

A bad plan for the construction of paper mills had been 
long in practice, under the assumed necessity of having 
a long, hollow roof over the Fourdrinier machines in order 
to prevent condensation of moisture over the machines, 
which was one of the worst features of these risks. The 
losses on paper-mills had been far in excess of the average 
loss on other risks. It therefore became necessary either 
to induce the owners to remedy the faults of construction, 
or else to drop the risks. The former course was taken, 
rates being advanced in the interval, and the Paper-Mill 
Mutual Company was organized, so that owners could be 
trained as directors in the right construction and protec- 
tion of their own risks. This action led to a complete 



386 YALE READINGS IN INSURANCE 

revolution in the layout and construction of paper-mills, 
and this change has been justified not only by the greater 
safety of the works, but by very great improvement in 
the methods of handling the stock. During the last ten 
years this company has not met a loss exceeding $5000 
on any paper-mill. 

Fires from the ignition of bituminous coal attracted 
our attention. It proved that there was but one variety 
of coal which had not taken fire, and since a preference 
or condition for the use of that coal would have given the 
owners a monopoly, costing consumers much more than 
any possible loss on the coal itself from spontaneous igni- 
tion, it was decided, with the assent of all parties in inter- 
est, not to insure bituminous coals against their own 
inherent hazard, maintaining the insurance of the property 
endangered by this cause of fire. Actual loss of calorific 
value by the slow coking of a pile of coal is not very great, 
although it has sometimes made a great deal of trouble 
in mill yards. Our present system is fully justified and 
has worked to the mutual benefit of our members. In this 
connection it may be related that we shall presently be 
able to present a report on fire retardent materials for 
wooden surfaces, which can be very cheaply applied to the 
wooden posts, which have not infrequently burned off in 
the coal piles, and which will entirely obviate that danger. 

Among the earlier lines of investigation was the test 
of the strength of wooden posts. The common practice 
had been to turn these posts, tapering from the base 
toward the top; this was a waste of material and weaken- 
ing of strength without any sound reason. Our tests 
proved the superiority of the square posts, chamfered off 
at the corners, with hole bored through the center, and a 
crossway hole near the top and bottom to ventilate and 
season the timber. This was followed by further tests 
of the strength of timbers, and the layout of plans for the 
construction of cotton factories consistently with the 
rather light weights per square foot of floor which 



FACTORY MUTUAL FIRE INSURANCE 387 

are found in this branch of industry. Other general 
plans for machine shops, paper-mills, etc., are also kept in 
stock. 

What the factory mutual companies have attempted 
is to give a proper direction to the use of timber, plank, 
brick, and concrete, so disposed that with proper apparatus 
fires may be reached in the beginning, or may be controlled 
before they attain destructive headway. Had we not been 
enabled to compass low cost and economy in construc- 
tion with adequate security against loss by fire, we should 
never have been able to accomplish the work which has 
been done. I have often asked, what has been the cost 
of fire protection in buildings rightly constructed accord- 
ing to our plans? It is not possible to give a positive 
answer to that question because the conditions vary with 
the different arts. In that branch of industry with which 
the factory system originated, namely, the manufacture 
of cotton, the conditions also vary very considerably, 
although not in so great a measure. We are accustomed 
to make all our computations of the cost of buildings, the 
appraisements for insurance and fire protection by the unit 
of the square foot of occupied floor; that is to say, of floor 
put to use in the manufacturing operations, in hallways, 
stairways, elevators, and the like, not including unoccu- 
pied basements unfit to be used which ought never to be 
tolerated anywhere. On this basis a tolerable average 
may be named. The average cost of adequate pumps, 
pipes, and hydrants within mill yards, not including outside 
connections or outside reservoirs, will not exceed 5 
cents per square foot of floor, and may often be put in 
position at less, any excess being due to extraordinary 
conditions. The cost per square foot of floor of auto- 
matic sprinklers may be put at an average of 3 cents. 
The entire cost will range from a minimum of 6 under 
favorable conditions to 8 cents under conditions which 
may not infrequently arise. In ratio to values this aver- 
age expenditure would stand at not exceeding 1J per cent. 



388 YALE READINGS IN INSURANCE 

for the pump, pipe, and hydrant service, and at an average 
of 1 per cent, for the sprinkler service. The cost per 
spindle will vary with fine or coarse work. 

One of the most useful functions, still continued in the 
physical laboratory, is the test and warning against fraud- 
ulent and dangerous claims or substances. This work 
has been especially effective in dealing with fancy oils and 
mixtures, belt dressings, lamps, heavy gases, or mechan- 
ical mixtures of naphtha or gasoline with air, claims for 
improvement in making steam, fire-proof material so- 
called, and other matters. 

The writer may hope that this record of progress in 
what may now be justly called the science of preventing 
loss by fire will have some influence outside the lines of 
the factory mutual companies. The present condition 
of the country in respect to loss by fire and contracts of 
indemnity given by insurance companies is somewhat 
alarming. All insurance, under whatever name, is a 
mutual contract to pay indemnity. Under the stock 
system the capital serves only as a guarantee. It must 
never be impaired in any great measure for the payment 
of losses and expenses. The losses and expenses must be 
covered by the premiums put in by the assured, and it 
is as impossible for an insurance company to give con- 
tracts of indemnity on less than cost for any long period 
of time as it is impossible for a factory to make and sell 
goods at less than cost without bankruptcy. The saga- 
cious managers of all insurance companies are now seeking 
for a remedy for the present dangerous conditions of under- 
writing. The ash heap due to loss by fire, the excessive 
cost of fire departments due to bad building and bad 
occupancy, and the cost of sustaining the insurance system 
of the country combined, coupled with the excessive de- 
mands for additional water supplies for fire purposes 
only, cannot amount to less than $200,000,000 a year, 
and is probably much more. 

I can find no trace of any annual profit on the entire 



FACTORY MUTUAL FIRE INSURANCE 389 

business of the nation which would warrant us in estima- 
ting the addition to the capital or savings of the people 
of this country, exceeding $1,500,000,000 even in a pros- 
perous year. It is probably less. It follows that the fire 
tax is certainly equal to 10 per cent, upon any possible 
profit of the nation, and is probably 15 per cent. It is 
equal to the normal cost of conducting the government of 
the United States under normal conditions, aside from 
pensions and interest on the national debt, that normal 
rate being $2.50 per head, amounting last year, on a peace 
basis, to a less sum than this fire tax. 

What is to be done to meet this waste? For the last 
ten years the representatives of the stock fire insurance 
companies, especially in Boston, have made consistent, 
intelligent, and determined efforts to bring about a change, 
and in some cities great progress has been made in pre- 
venting loss, notably in this city of Boston. But in some 
other cities the danger of a most destructive conflagration 
still exists, and it is probably only a question of time when 
such a conflagration will occur, rendering a large part of 
the stock insurance companies bankrupt which may have 
large lines in such cities. Without those large lines of 
insurance their business could not be conducted under 
existing conditions. This danger of most destructive 
conflagrations can neither be met by legislation nor by 
insurance companies. The owners and occupants of 
these dangerous and combustible buildings and districts 
are responsible for this great danger and must pay the 
penalty; until they act in combination under intelligent 
advisers big fires are their own fault. 

Although the method of granting contracts of indem- 
nity by the factory mutual companies must, of necessity, 
be limited to special establishments, each carefully guarded 
from the other and fitted with its own apparatus for the 
extinction of fire, yet there are vast fields not yet covered 
by this mutual method. The more hazardous the work, 
the more reason for adopting this system of preventing 



390 YALE READINGS IN INSURANCE 

loss. All the wood-working establishments and many 
other branches of industry might be combined in the same 
way ; the only thing necessary being to overcome the antag- 
onism with which owners usually regard the underwriters, 
and to bring them together as co-partners, under a sufficient 
deposit, each sustaining the other in the effort to find 
out the causes of danger and to remove them. 

A mutual insurance company might be organized for 
the insuance and prevention of fire in church buildings. 
We burn 11.36 churches per week in the United States. 
By combination for mutual insurance the church mem- 
bers might be assured against cremation in this world, if 
not in the next. 

A very large part of the great shops and department 
stores are badly planned, little consideration having been 
given in their construction to danger of fire, except in 
some cases in choosing the material of which the buildings 
are constructed. Fires have spread with extreme rapid- 
ity over open stocks, even in fire-proof buildings, so-called, 
in which there have been many openings or stairways 
passing from one floor to another, to the complete destruc- 
tion of the contents. The factory underwriters regard the 
vertical hazard much greater than the horizontal hazard. 
They are obliged to deal with very large floor areas, very 
often of one acre each, sometimes much larger, covered 
with combustible material. But since the introduction 
of automatic sprinklers all fires have been stopped with 
moderate loss from any great horizontal spread. No fire 
has passed from one floor to another, in any building 
insured under the supervision of the undersigned, by burn- 
ing away the thick plank floor in any working department 
of any mill. In one instance, a fire originating at the 
bottom of a pile of jute in a storehouse burned through 
the floor, making a porthole through which a stream of 
water was thrown to the heart of the fire. The fires 
which have passed upward or downward from floor to 
floor have passed either through belt openings which are 



FACTORY MUTUAL FIRE INSURANCE 391 

now nearly abolished, or, getting by the doorways, have 
passed through the elevator shafts or stairways. 

The true model of a great department store may at 
some future date be a building without any windows in 
the walls except, perhaps, in the upper story, if a top or 
roof light does not suffice to show goods for which daylight 
is needed, electricity serving to give light, and a forced 
circulation of air warmed and cleansed giving better 
ventilation than can be attained by opening or closing 
windows. Such an establishment might be built with pas- 
sages from floor to floor in separate towers, or stair cham- 
bers at each corner, each carefully cut off at each floor by 
automatic fire-doors and with no other openings from 
floor to floor. The latest storehouses in cities, where nar- 
row areas make it necessary to construct buildings of 
many stories in height, have been built substantially on 
this plan. This may seem a somewhat visionary idea, 
but what stands in the way? If show windows are needed 
around the lower story, they can be cut off by fire-proof 
walls and ceilings from the interior, lighted and protected 
separately from the main building and entered from the 
towers. 

While it may not be possible to apply all the rules and 
methods to the miscellaneous hazards of a city, yet a very 
large part of the safeguards which are required by the 
mutual companies, as a condition of insuring property, 
have been brought into use for the protection of the com- 
mercial hazards of cities and can be extended rapidly 
when owners and occupants can be aroused to the neces- 
sity. 



CHAPTER XXII 



STEAM BOILER INSURANCE 



That there is a legitimate field for steam boiler insurance 
is shown by the statistics of steam boiler explosions that 
have been kept for the past forty years by the Hartford 
Steam Boiler Inspection and Insurance Company. From 
these it appears that from October 1, 1867, to December 
31, 1908, there were no less than 10,051 such explosions 
in the United States and adjaeent parts of Canada and 
Mexico, resulting in the deaths of 10,884 persons, and in 
more or less serious injury to 15,634 others. No data as 
to the loss of property caused by these explosions are 
available, but there is no doubt that it was very large 
indeed. 

Sir William Fairbairn, in 1854, founded the first associa- 
tion for the systematic inspection and general supervision 
of steam boilers, his association being now known as the 
Manchester Steam Users' Association, with headquarters 
in Manchester, England. The Hartford Steam Boiler 
Inspection and Insurance Company, organized in 1866, 
was the first company formed in the United States for a 
like purpose, though it differed from the Manchester asso- 
ciation from the start, in offering a large indemnity, in 
case the boilers placed under its care should explode. 
There are now (1909) some thirteen companies doing steam 
boiler insurance in the United States, though the Hart- 
ford Company is still the only stock company that con- 
fines its activities to this one line of work alone. 

1 By A. D. Risteen. Reprinted, with additions, from pages 250-271 
of the "Yale Insurance Lectures, Fire and Miscellaneous," 1904. 

392 



STEAM BOILER INSURANCE 393 

In boiler insurance the fundamental object ought to be, 
to prevent explosions so far as possible. The life insurance 
companies cannot guard themselves in this manner, save 
in the most general way. The fire companies can do much 
more, and they do aim to prevent fires so far as possible 
by a system of inspection which is designed to detect and 
remove special sources of danger. The boiler insurance 
companies can go even further in this direction, however, 
and experience has shown that it is possible, by thorough 
inspection, to prevent explosions in a very large measure. 
Prevention, then, is the key-note of successful boiler insur- 
ance ; and a very large proportion of the income of a boiler 
insurance company is expended in the making of inspec- 
tions, and in other similar services to the assured, which 
tend to lessen the likelihood of an explosion. The Hart- 
ford Company maintains a chemical laboratory, for ex- 
ample, in which troublesome feed waters are analyzed, 
and appropriate methods discovered for the treatment of 
these waters, so that they may be used successfully in the 
boilers in which they have been found to give trouble. 
It also maintains a department of design, in which plans 
and specifications for boilers and boiler settings are pre- 
pared for the assured, no charge being made for these 
unless the labor involved is considerable ; and in that case 
the charge is merely nominal, and is intended simply to 
cover the actual expense to which the insurance company 
is put. 

I imagine that you will want to know something about 
the way in which the premiums that are received by 
the boiler insurance companies are expended. I cannot 
answer this for others, but so far as the Hartford Company 
is concerned, it may be said that the premium receipts 
are divisible into a maximum portion of about 80 per cent, 
of the whole, and two minimum portions of about 10 per 
cent. each. One of the 10 per cent, portions stands for 
the profit of the business, and the other represents what 
may be regarded, roughly, as the amount set aside to 



394 YALE READINGS IN INSURANCE 

provide for the payment of losses due to explosions. The 
80 per cent, portion represents what is expended in procur- 
ing the risks, and in inspecting them with such care as to 
keep the losses within the 10 per cent, limit. Experience 
has shown that it is good business policy to expend a very 
large portion of the total premiums in the making of inspec- 
tions, and it is hardly necessary to say that the insurance 
company is also under moral obligation to its patrons to 
maintain an inspection service of the highest order of 
excellence. 

The general method of conducting the business of boiler 
insurance at the present time will best be made clear, per- 
haps, by tracing the steps by which an insurance contract 
in this field is made and consummated. 

The boiler owner being assumed to be persuaded of the 
wisdom of taking out a policy, the next questions to be 
determined are these: (1) The term, or duration, of the 
policy. (2) The amount for which it shall be written. 
(3) The premium that shall be paid. 

First, as to the term of the policy. This happens to be a 
very simple matter, for nearly all boiler insurance policies 
are written for three years, and it is only under exceptional 
circumstances that this practice is modified. I may as 
well explain, once for all, that what I shall have to say 
relates to the great mass of the business of the company 
with which I am connected; and it is to be understood 
throughout that when a statement is made, it merely 
represents this general practice. Reasonable persons may 
nearly always be expected to do reasonable things; and 
boiler insurance companies are always willing to take 
account of any exceptional conditions that a given case 
may present, and to modify their practice accordingly; 
— provided the proposed modification does not interfere 
with the desirability of the risk. The general rule of the 
business is, then, to write policies for three years. 

Second, as to the amount for which the policy is to be 
written. This problem and the third one, — namely, the 



STEAM BOILER INSURANCE 395 

amount of the premium, — are intimately connected. 
For it is evident that the total amount of the premium 
must be sufficient to repay the insurance company for 
the expenses incurred in obtaining the risk, and for those 
incurred in inspecting the boiler periodically while it is 
insured; and there must also be an excess, over and above 
these sums, to be set aside for the payment of such losses 
as may be incurred by explosion. In the early days, it 
was customary to fix the rate to be charged by means of 
a sort of sliding scale, the rate being higher for high pres- 
sures than for low ones, and higher for boilers that had 
been in service for some time than for those that were 
just out of the maker's shop. At the present time, how- 
ever, it is not the practice to vary the rate in this manner; 
and the great bulk of the business is now written at a uni- 
form rate of 1 per cent, for the three years, provided the 
face of the policy is great enough for this rate to yield 
a premium sufficient to cover the three items just noted; — 
that is, the expense of obtaining the risk, of inspecting it 
periodically, and of insuring it. It is not profitable to 
insure isolated boilers at this rate for a smaller sum than 
$5000 each; the rate of 1 per cent, for three years yielding, 
in this case, the sum of $50 for the three years, or an 
average premium of $16.67 per annum. 

In large plants, where there are many boilers, a smaller 
sum than $5000 per boiler may be sufficient; for in such 
plants the inspectors can usually arrange to examine several 
boilers on each trip, and thus reduce the expense of inspec- 
tion per boiler. A battery of ten boilers, for example, 
might reasonable be insured for $40,000, at a rate of 1 per 
cent, for three years; this yielding a total premium for 
the three years of $400, which is at the rate of $133 J per 
annum for the ten boilers. The business should be good 
at this figure, if several of the boilers can be had for inspec- 
tion at the same time, and if the plant is not too far re- 
moved from the ordinary routes of travel. In general, 
therefore, the face of the policy is computed by allowing, 



396 YALE READINGS IN INSURANCE 

for each boiler in the plant, something like $5000 if the 
plant is a small one, or somewhat less than this if it is a 
large one; and the total premium to be paid for the three 
years that the policy is to run is then computed by taking 
1 per cent, of the face of the policy as so determined. It 
will be readily understood that when the risk is of an 
unusual character, this general rule has to be modified 
accordingly. For example, a single high-pressure boiler, 
bursting in the basement of a factory whose product or 
machinery is especially valuable, might easily do far more 
than $5000 of damage; and if numerous workmen were 
employed in parts of the building near to the boiler, the 
likelihood of a considerable loss of life and personal injury 
would have to be considered specially. The face of the 
policy would then naturally be increased, so as to take 
account of the probable gravity of the results of an explo- 
sion. The rate charged for the insurance would not ordi- 
narily be raised in such a case, however; for the standard 
rate of 1 per cent, for three years, would yield a larger 
gross premium, and the expenses of solicitation and inspec- 
tion being fixed, it is evident that that part of the pre- 
mium which would be available for the payment of losses 
would be proportionately greater with the large premium 
than with the smaller one; and the insurance company 
therefore has a larger proportionate sum that can be set 
aside to provide for the increased possibility of a serious 
explosion. 

I cannot emphasize too strongly the fact that there is 
no rate at which a boiler is insurable, when there is any 
reason to doubt its safety. In fire insurance an extra 
hazardous risk may be provided for by an increase in the 
rate of insurance; but in boiler insurance this practice is 
not followed. It is considered that the ordinary hazards 
that are necessarily attached to the use of high pressure 
steam are quite great enough; and a boiler that is not 
regarded as safe for the pressure* to be carried, is not con- 
sidered to be a fit subject for insurance at any rate whatso- 



STEAM BOILER INSURANCE 397 

ever. Moreover, I may add that experience has shown 
that in boiler insurance the moral hazard is negligible. 
Men doubtless burn their own property occasionally, for 
the purpose of recovering the insurance upon it; but it is 
doubtful if they ever intentionally cause their own boilers 
to explode. 

It being assumed, now, that the agent and the boiler 
owner have agreed upon the term of the insurance, and 
upon the sum for which the policy is to be written, and 
upon the premium that is to be paid, the next step is to 
make out a formal application for the insurance. Suit- 
able blanks are, of course, provided for this purpose, and 
the agent fills them in by specifying the number, type, and 
location of the boilers, the name of the person or corpora- 
tion owning them, the face of the policy desired, the term 
for which the policy is to run, and the premium that is to 
be paid. The owner then signs this application, and his 
signature completes his relations with the agent. 

The application, thus made out, is then forwarded to the 
home office, or to the branch office to which the agent is 
accredited. The next step is analogous to the correspond- 
ing one in life insurance. In life insurance, after the appli- 
cation is made out, the question arises, whether or not the 
medical examiner will accept the risk; and this point is 
determined by making a careful physical examination of 
the applicant. So in boiler insurance, the next step after 
the delivery of the application is for the insurance com- 
pany to send, to the mill or factory, one of its experts in 
steam boiler construction and management, to pronounce 
judgment upon the condition of the boilers, and to give 
his opinion as to whether they are or are not in insurable 
condition. This expert is technically known as an " in- 
spector." After having made arrangements with the 
owner to have the boilers cool and ready for examination, 
the inspector proceeds to the plant where they are located, 
and examines them with great care. I think that I may 
safely say, that his examination is even more searching 



398 YALE READINGS IN INSURANCE 

than that which is given in the case of life insurance. 
If the boilers are of a type that will admit of it, he enters 
them, crawling all about them internally, and noting the 
dimensions and the actual present condition of every essen- 
tial part. He also makes a corresponding examination of 
the external surfaces, recording the thickness of the plates, 
the pitch of the rivets, and many other items that have to 
do with the strength of the boiler, and its ability to with- 
stand safely the working pressure that the owner desires 
to carry. The numerical data that he thus obtains are 
entered in blank spaces that are provided upon the inner 
pages of the same application that the owner has signed. 
To give some idea of the minuteness of his examination, 
I may say that the blanks that he has to fill out contain 
forty-two main questions, many of which have several sub- 
questions under them, so that in all he has to answer 
perhaps as many as seventy-five different questions. I 
cannot give the exact number, because it naturally varies 
a little, with the type of boiler. Questions relating to 
water tube-boilers, for example, are passed over when the 
boilers under consideration are of the fire-tube type. 

It sometimes happens that the boilers are of such small 
size, or of such a type, that they cannot be actually entered 
by the inspector. In cases of this kind, he has to infer 
their internal condition by making an examination through 
the several small openings that should always be pro- 
vided in such boilers, and which are technically known as 
"hand-holes." In such cases he also applies a "hydra- 
static pressure" to the boilers. This consists in filling 
them entirely up with water, and then forcing a small 
additional quantity of water into them by means of a 
pump. By this means a considerable stress is easily 
brought upon the boilers, and when they are thus under 
pressure, the inspector notes, carefully, whether or not 
they show signs of distress. The distress may make 
itself manifest by leakage from r the joints or tube ends, or 
by the breakage of some essential part, or by the bulging, 



STEAM BOILER INSURANCE 399 

collapse or rupture of some portion of the boiler, or in 
other ways that I do not need to mention specially. 

Having made a thorough examination, the inspector 
fills out the blanks provided for this purpose upon the 
inner pages of the original application, and then transmits 
the application to the chief inspector of the office from 
which he comes. He also gives his judgment, based upon 
the construction, age, and condition of the boilers, and 
upon his previous experience with boilers of the same 
type, as to the working pressure that the boilers can safely 
withstand. And, finally, he submits a written report to 
his office, describing in detail the condition in which he 
found the boilers; a copy of this report being subsequently 
forwarded to the boiler owner. It often happens that a 
thorough inspection of this sort results in the discovery 
of some defect or structural weakness, which may even be 
imminently dangerous, and which had not been previously 
suspected. In such a case the fact is, of course, imme- 
diately reported to the boiler owner, and definite recom- 
mendations are made as to the alterations or repairs that 
are required in order to put the boilers into safe condition 
again. The owner is also informed that the negotiations 
can proceed no further until the suggested alterations 
have been made, and the inspector has subsequently satis- 
fied himself by a second inspection, not only that they 
have been made, but that they have been made properly 
and well. 

It sometimes happens, too, that the preliminary inspec- 
tion discloses the fact that the boiler is in such bad shape 
that it would be impossible, or at least unprofitable, to 
try to repair it; and in this event the inspector condemns 
it; — or, which is the same thing, he pronounces it unin- 
surable. I should like to state, however, that wholesale 
condemnation is not favored by the boiler insurance com- 
panies. They would indeed like to insure nothing but 
ideally perfect boilers; yet in condemning boilers that are 
already in service, the inspector is expected to exercise 



400 YALE READINGS IN INSURANCE 

his best judgment, in accordance with safe rules, for the 
benefit of all concerned ; — that is, on behalf of the in- 
sured, as well as of the company that employs him. His 
judgment is a disinterested one, so far as he is concerned 
personally, for his compensation is the same whether he 
accepts the boiler or rejects it. His company will not 
insure a boiler that is believed to be unsafe, nor does the 
owner desire to replace a boiler that is really safe and 
satisfactory, merely because the inspector would like 
him to have a somewhat better one. The task of the 
inspector who condemns a boiler is therefore seen to be a 
delicate one, involving a number of important considera- 
tions; and he is required to give his superior officers in 
the insurance company full and sufficient reasons for his 
condemnation, so that the prospective insurer may be 
really satisfied, in his own mind, that the condemnation 
is justifiable from his own point of view, as well as from 
that of the insurance company. I may say that in our 
own practice we rarely find the boiler owner dissatisfied 
with the reasons for condemnation that are furnished to 
him. We cannot force him to replace a defective boiler 
with a new one; but we almost invariably find him ready 
to give proper attention to our criticism; and when he 
really ought to have a new boiler, it is seldom difficult to 
convince him of that fact. 

Assuming, now, that the inspector has satisfied himself 
that the boilers upon which insurance is desired are really 
in good condition, the next step is the review of the opinion 
of the inspector by the chief inspector of his department. 
This corresponds to the medical director's review, in life 
insurance, of the opinion given by the examining physician. 
The chief inspector takes in hand the various measurements 
and other data obtained by the inspector's examination, 
and by the aid of them he carefully computes the safe 
working pressure that his company would be willing to 
allow the boiler to carry. Usually the estimate so ob- 
tained will be found to agree satisfactorily with that given 



STEAM BOILER INSURANCE 401 

by the inspector; but it sometimes happens that this 
careful calculation reveals a source of weakness at some 
point, whose importance the practical eye of the inspector 
did not perceive ; and in such a case the owner of the boiler 
is notified of the finding, and he must see that the error 
of construction is remedied before the insurance company 
will take any further steps towards the issuance of his 
policy. 

If the inspector and the chief inspector are both satis- 
fied of the safety of the boiler at the time that it is offered 
for insurance, the policy is issued to the owner, who is 
thereafter protected, up to an amount equal to the face of 
the policy, against loss of property from the explosion, 
rupture, or collapse of his boiler or of any part of it, 
owing to the pressure of steam. He is also protected 
(always within the amount for which the policy is written) 
for any loss or damage to which he may be subjected, 
from the same cause, by reason of the destruction of his 
neighbors' property, or by reason of loss of life or of per- 
sonal injuries to any persons whatever. The damages 
from loss of life, or from personal injuries, are determined, 
in this line of insurance as well as in other lines, by the 
earning capacity of the victims; and also, in the case of 
personal injuries, by the time during which the unfor- 
tunate ones are incapacitated. It is usual to specify 
in the policy, however, that the liability of the insurance 
company shall not exceed $5000 in the case of any one 
death. 

After the issuance of the policy, the insurance company, 
primarily for its own protection, but also incidentally in 
the interest of the assured, regularly makes a certain num- 
ber of inspections of each boiler, per annum (usually four) ; 
and it reserves the right of access, at any time, to the 
boilers that are insured, and to any and all machinery 
that may be concerned in the safe operation of the boilers. 
Of the four inspections that are made per annum, at least 
one is a complete internal and external inspection, sim- 



402 YALE READINGS IN INSURANCE 

ilar to that which is given at the outset, except that it is 
not necessary to repeat the measurements, these being 
made once for all. The inspector making these complete 
inspections prepares a detailed written report in each 
case, stating in full the condition in which the boilers 
were found; and a copy of every such report is transmitted 
to the owner of the boilers. 

In these routine inspections, it often happens that the 
inspector finds that defects or weaknesses have developed, 
in the course of the service of the boilers; for boilers, like 
all other structures that are put to constant use under 
trying conditions, wear out, and develop troubles of vari- 
ous kinds. In fact, the number of different ways in which 
steam boilers can go wrong would surprise any person not 
familiar with the general facts of the case. Many of the 
defects that are discovered in this way, and pointed out 
to the owners, are of such a nature that they would be 
overlooked by the regular attendant. For the regular 
attendant, even although he has been in charge of boilers 
for many years, and may be an unusually competent 
engineer or fireman, has at most seen but few boilers, and 
so far as his actual experience goes, he cannot be expected 
to be familiar with many different kinds of defects. The 
inspector of the insurance company, on the other hand, 
has seen hundreds and perhaps thousands of boilers, and 
has watched many of them from year to year, under the 
most varying conditions; and his training has fitted him 
to detect and forsee intelligently the consequences of defects 
whose importance the man in immediate charge of the 
boilers would probably never adequately appreciate. 

Defects that develop in use, and which are detected in 
the course of the regular periodical inspections, are pointed 
out to the owner of the boilers in the written reports that 
are submitted to him. If they are considered trivial, 
that fact is indicated, and he is requested to bear them in 
mind, so that any tendency that they may manifest towards 
increase may be promptly noted. If they are considered 



STEAM BOILER INSURANCE 403 

to be bordering upon danger, his attention is similarly 
directed to them, and he is requested to have the neces- 
sary repairs made at his earliest convenience; the fact that 
they have been properly made being subsequently veri- 
fied by the inspector in person. If they are still more 
serious, and are considered by the inspector to be immedi- 
ately dangerous, the owner is notified of this fact also, 
and he is warned not to put the boiler into service again 
until it has been made safe. Of course, the insurance 
company has no way in which to enforce its recommenda- 
tions; but if compliance with them is refused, the company 
reserves the right to cancel the insurance at once, and 
few owners care to incur this penalty. For it is univer- 
sally admitted that the inspectors are, as a class, men of 
wide experience and good judgment; and if an explosion 
should occur after the owner has refused to comply with 
their suggestions, and has had his policy canceled in 
consequence, he will lose not only the insurance, but he 
will also be liable to be subject to heavy suits for damages, 
on the ground of culpable negligence in refusing to act 
upon the advice that the inspector gave him, before the 
accident. 

When policies are discontinued in this manner, it is 
customary for the insurance company to return to the 
assured a certain fraction of the total premium that has 
been paid. The amount so returned is fixed by deducting 
from the premium a sum sufficient to compensate the com- 
pany for the actual expense to which it has been put, and 
then returning a pro rata fraction of the balance. That 
is, of the balance remaining after deducting expenses, 
the assured receives an amount which stands to the whole 
balance in the same proportion that the unexpired part 
of the term of the policy bears to the whole term. 

In order that you may have some idea of the scale upon 
which boiler inspections are now made, I may say that in 
the year 1908 the Hartford Company (which constantly 
employs more than 200 inspectors) made 124,990 complete 



404 YALE READINGS IN INSURANCE 

internal and external inspections of steam boilers, and 
detected 151,359 defects, of which 15,878 were considered 
to be dangerous. In the same year it condemned no less 
than 572 boilers as unsafe for further use, good and suffi- 
cient reasons for such condemnation being given in every 
case. From the beginning of its business down to Janu- 
ary 1, 1909, it had similarly condemned 19,700 boilers, 
and when it is remembered that in most of these cases 
the owners had no idea of the danger of their boilers until 
the inspector had visited them, you will see that there is 
some substantial ground for our claim that boiler insurance 
is (or should be) very largely preventive. 

I have said that it is customary to make at least four 
inspections of each insured boiler per annum, and I have 
also said that at least one of these is a complete internal 
and external inspection, of which the owner is notified in 
advance, and for which he has his boilers cooled and 
emptied and otherwise prepared. The remaining inspec- 
tions are technically known as "externals/' since they are 
made while the boiler is in service, and must therefore be 
confined to the examination of such conditions as can be 
observed or inferred without entering the boilers. No 
notification is given in advance of these visits, and conse- 
quently no preparation is made for them. The intention 
is that the inspector shall have the opportunity of viewing 
the plant when his coming was not expected, so that he 
may see it under the ordinary running conditions. He 
examines the safety valve to assure himself that it is 
working freely, notes the pressure that is being carried 
and compares it with the limit that the policy fixes, ob- 
serves the height of the water in the boiler, and tries the 
gauge cocks to see if they and the water glass are free. 
In short, he looks about him generally, to make sure that 
the boilers are in safe hands, and that they are being 
cared for properly. 

To illustrate the importance of these " external' ' inspec- 
tions, let me cite one instance that came under my notice. 



STEAM BOILER INSURANCE 405 

One of our inspectors from the Hartford office visited a 
cotton-mill in Massachusetts for the purpose of making an 
"external" examination under ordinary running condi- 
tions, and found that nobody was present. The attend- 
ant had doubtless been there within a short time, but he 
had vacated the premises for some purpose. 

The inspector had hardly entered the room when his 
experienced ear detected a noise of escaping steam, which 
he felt assured was not due to any ordinary leakage about 
a pipe joint. Passing to the rear end of one of the boilers, 
he opened a door in the brick setting, and speedily satis- 
fied himself that serious trouble was imminent. In an 
emergency of this kind, the first thing to do is to draw 
the fire from under the boiler, and (when there are several 
boilers running together) shut the valve in the steam 
pipe that connects this boiler to its neighbors. By this 
means the pressure in the suspected boiler is caused to fall 
gradually, so that the boiler becomes every moment safer. 
The inspector was just finishing this operation when the 
attendant returned and, not knowing who he was, chal- 
lenged him for interfering with the plant. Explanations 
followed, and when the boiler had cooled sufficiently to 
permit of examination, it was found that the brick arch 
over the rear end of the furnace had fallen down, allow- 
ing the incandescent products of combustion to strike 
directly against the upper part of the rear head; and this, 
being unprotected by water, had become overheated to 
such a degree that the back head had bulged out, and the 
brace rivets had drawn through their holes, permitting 
the steam in the boiler to escape and make the sound 
which had first attracted the inspector's attention. I do 
not know how many of you will find this technical descrip- 
tion intelligible; but permit me to say that the accident 
was of a very serious kind, and that it is probable that in 
a few minutes more the entire back head of the boiler 
would have blown out, with a consequent sudden libera- 
tion of energy sufficient to destroy the boiler house, and 



406 YALE READINGS IN INSURANCE 

perhaps a considerable part of the main mill adjoin- 
ing it. 

In conclusion, let me state the methods that are followed 
in the settlement of losses. When, in spite of the care 
taken by the inspectors, a boiler explodes and entails 
loss of property, and probably also loss of life and injury 
to person, the assured is supposed to notify the insurance 
company of the loss as promptly as possible. The insur- 
ance company then sends its adjuster to the scene of the 
explosion, and he performs two duties. One of these 
consists in looking over the ruins in the interest of the 
insurance company, so as to learn the cause of the explo- 
sion, so far as possible. The information obtained in 
this way has been found to be very serviceable in the pre- 
vention of other explosions from similar causes; so that in 
this way all the patrons of the insurance company derive 
an indirect benefit from every explosion upon which the 
insurance company loses. The adjuster also looks over 
the damaged property in company with some representa- 
tive of the owner, and together they attempt to reach a 
fair estimate of the amount of the loss. It usually hap- 
pens that an agreement of this sort can be reached with- 
out trouble; but in case of an irreconcilable difference of 
opinion, some third and presumably disinterested person 
is agreed upon as an arbitrator. The loss or damage to 
which the assured has been subjected being determined, 
the insurance company forwards its draft in settlement at 
the earliest date possible, in order that the assured may 
not be embarrassed any more than necessary in the repair- 
ing of the damage to his plant. The compensation to be 
awarded by the assured to the injured and to the legal 
representatives of the killed are determined in a similar 
manner, and the award agreed upon is included, of course, 
in the draft that is forwarded to the insured. 

The usefulness of the boiler insurance company should 
not cease with the payment of the loss; because the rep- 
resentatives of the insurance company have seen so many 



STEAM BOILER INSURANCE 407 

cases of destruction from boiler explosions that they are 
usually capable of giving valuable advice as to the best 
methods of clearing away the wreckage, and of restoring 
the plant to its original condition of efficiency. Services 
of this kind are freely rendered, and no charge is made 
for them; for it is understood, throughout the relations 
of the insurance company and the assured, that the inter- 
ests of the assured are to be safeguarded and promoted in 
every way possible. 

You will see, from what has been said, that boiler insur- 
ance differs in many respects from insurance of other 
kinds. It does not involve statistical studies to any con- 
siderable extent, and the problems that arise in it are 
mainly those relating to constructive engineering, and to 
the practical management of boilers, and to the detection 
of such defects as the boilers may develop in the course 
of their operation. 

Every boiler owner will naturally ask himself, before 
he takes out insurance, whether the chance that a given 
boiler will explode is great enough to warrant him in pay- 
ing the premium that is asked by the company that 
proposes to insure it. Most of the boiler owners of the coun- 
try have already answered this in the affirmative, as is 
shown by the fact that they have accepted the insurance. 
It is helpful, however, to look at the matter from the fol- 
lowing point of view. I have told you that experience 
shows that a rate of 1 per cent, for three years is sufficient 
to enable the insurance company to carry on its business 
soundly and with profit. This corresponds to an annual 
charge of one three-hundredth part of the face of the policy. 
Hence if the face of the policy fairly represents the dam- 
age that an explosion would be likely to cause (including 
death claims and claims for personal injuries), it is plain 
that the insurance company's rate is equivalent, from the 
standpoint of the theory of probabilities, to an even bet 
that an insured boiler, when inspected and cared for as 
the insurance company actually does inspect and care 



408 YALE READINGS IN INSURANCE 

for it, would not blow up in three hundred years, if the 
natural and inevitable deterioration of the boiler through 
use would permit of its being kept in service for that length 
of time. I think I need hardly say that a rate which is 
based upon a probability of this sort cannot be considered 
to be in the least degree exorbitant. An even bet that a 
given boiler would not explode if run continuously from 
the death of Queen Elizabeth down to the present day, 
under the stated conditions, appears to be quite a reason- 
able one from the standpoint of the owner; and in addi- 
tion it should be remembered that he has the advantage 
of expert inspections during this whole period, these alone 
being worth more than the entire sum that he pays, be- 
cause they tend to lessen his repair bills, and to increase 
the efficiency of his boilers. 



